DB schemes continue recovery in Q3 but covenant risks remain
The health of the UK’s Defined Benefit (DB) pension schemes has almost returned to their pre-COVID levels as they continued to recover through Q3 2020, according to Legal & General Investment Management (LGIM)
16 Nov 2020
Full press release
- DB schemes in the UK can expect to pay 95.5% of accrued pensions benefits
- This is just one percentage point below the pre-COVID levels of December (96.5%) and a significant improvement on the figures from March (91.4%)
- However, LGIM warns of new threats to funding ratios, with DB schemes facing weakening covenants from corporate sponsors due to the ongoing recession
LGIM's Health Tracker, a monitor of the current health of UK DB pension schemes, found that the average1 DB scheme can expect to pay 95.5% of accrued pension benefits as of 30 September 2020, up 2% from 30 June 20202.
This compares to the pre-COVID level of 96.5% from 31 December 20193 as well as the lows of 31 March 20204 which saw funding levels drop to 91.4%.
The latest quarterly analysis, which takes into account the risk that a sponsor might default and the impact that would have on scheme members, means that 4.5% of accrued pension benefits would not be paid on average across their scenarios in Q3 2020, compared to 6.5% in June 2020.
The most significant market movements behind the improvement include strong performance of growth assets and a rise in nominal interest rates, whereas inflation expectations remained broadly the same.
John Southall, Head of Solutions Research at LGIM: "It’s great to see things improving once again this quarter. As previously, however, we would caveat that these higher ratios may understate the negative impact of COVID since the start of the year, due to a weakening of covenants that many schemes will have endured. The extent of covenant deterioration is not yet clear. Our calculations are based on a typical sponsor rating of around BB. If this were to fall to B, for example, we would anticipate an Expected Proportion of Benefits Met (EPBM) value around 2% lower, wiping out the gain seen this quarter."
Christopher Jeffery, Head of Rates and Inflation Strategy at LGIM: "Since March, global risk assets and nominal yields have been driven higher by anticipation of an economic recovery as the world learns to cope with COVID. In recent weeks, those trends have been given an additional fillip by the US election and news of a breakthrough in the search for a vaccine. As a consequence, the gilt market has downgraded the likelihood of negative interest rates from the Bank of England in 2021 and beyond. RPI reform is now around the corner, with an announcement pending in late November, which constitutes the next major event risk for DB schemes to navigate."
