07 Sep 2022 2 min read

The end (game) is nigh: UK DB health at an all-time high

By John Southall , Yikai Shen

Our latest research reveals that UK defined benefit (DB) schemes are at their healthiest-ever levels, putting the ‘endgame’ in sight for the majority of schemes within the next five to 10 years.

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Our DB Health Tracker, a monitor of the current health of UK DB pensions schemes, suggests that the average DB scheme1 can expect to fund 98.8% of accrued pension benefits, as of 30 June 2022.

This is a rise of 0.3 percentage points from the 98.5% recorded three months prior on 31 March 20222 and signposts the continual improvement of the country’s DB pension schemes, which dropped to a low of 91.4% in March 20203 in the immediate aftermath of the COVID-19 pandemic.

LGIM’s measure of scheme health, called Expected Proportion of Benefits Met (EPBM) doesn’t only consider funding levels. It is calculated based on simulating many potential ultimate outcomes for schemes (in terms of the fraction of benefits currently promised that are ultimately met) and taking their average. This allows it to also capture long-term risks such as sponsor insolvency and its timing. We believe it offers a powerful lens through which to guide investment strategy, such as when to move into cashflow-matching strategies.

Critical months ahead

In the second quarter of 2022, the substantial rise in both long-term nominal interest rates, combined with the fall in long-term expected inflation, led to an increase in long-term real interest rates. This increase in both nominal and real rates has benefited a typical DB scheme due to underhedged liabilities, but was largely offset by poor performance of growth assets relative to expectations. Overall, though, our EPBM measure managed to post a small gain and reached a new high.

While the recessionary clouds that are gathering might ordinarily lead to significant downward pressure on yields, the current inflationary backdrop is preventing that from happening and is propping up scheme health, at least for now.

Where markets and scheme health will go from here is hard to predict, but many schemes will be looking to lock in their strong positions and accelerate their plans for endgame. We will continue our quarterly updates on the health of the UK’s DB schemes and share the results with our clients and the readers of our blog.

 

1. Based on the Purple Book from the Pension Protection Fund, a typical pension scheme holds approximately 20% in equities, 70% in bonds/LDI, 5% in property and 5% in other assets.  We are tracking a ‘typical’ scheme we set up in 2018 when we estimated its funding position based on data from the PPF. For illustration, we currently assume rates and inflation hedge ratios of 70% of liabilities on a gilts basis and no future accrual or deficit contributions.

2. As of 31 March 2022, the LGIM DB Health Tracker found that our typical pension scheme could expect to pay 98.5% of accrued pension benefits.

3. As of 31 March 2020, the LGIM DB Health Tracker found that our typical pension scheme could expect to pay 91.4% of accrued pension benefits.

John Southall

Head of Solutions Research

John works on financial modelling, investment strategy development and thought leadership. He also gets involved in bespoke strategy work. John used to work as a pensions consultant before joining LGIM in 2011. He has a PhD in dynamical systems and is a qualified actuary.

John Southall

Yikai Shen

Quantitative Associate

Yikai works as a quantitative associate in LGIM's Solutions group. Yikai assists in financial modelling and investment strategy development work. Yikai joined LGIM in August 2020 from Duff & Phelps, where he was an associate within the complex asset solution team and assisted in the valuation of credit derivatives. He obtained a master's degree in Maths and Finance from Imperial College London.

Yikai Shen