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Pension deficits claw back 2% in Q2 – but continued Covid covenant risks could be understated

The overall health of the UK’s Defined Benefit (DB) pension schemes moderately improved during Q2 2020 following the impact of the pandemic in the first quarter, but Q1-aside, it still remains at a two-year low, according to Legal & General Investment Management (LGIM).

18 Aug 2020

Full press release

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 93.5 per cent of accrued pension benefits as at 30 June 2020, up from 91.4 per cent at 31 March 20202. This compares to a figure of 92.9% recorded as at 30 June 2018.

This measure of the ‘Expected Proportion of Benefits Met’ (EPBM) has improved by 2.1 per cent during the first three months of the year but is still down from 96.5 per cent in December 2019.

The latest quarterly analysis, which takes into account the risk that a sponsor might default and the impact that would have on scheme’s members, means that 6.5 per cent of accrued pension benefits would not be paid on average across their scenarios in Q2 2020, compared to 8.6 per cent in March.

The most significant market movements behind the 2.1 per cent improvement include a rebound in growth assets during the quarter. This followed aggressive stimulus from policy makers and a general improvement in investor sentiment. However, nominal interest rates continued to fall over Q2, albeit less than during Q1. Moreover, inflation expectations have now grown, in contrast to a fall during Q1. Due to a typical scheme under-hedging their rates and inflation risk, these two factors offset some of the gains from the rally in growth assets.

John Southall, Head of Solutions Research at LGIM: "It’s great to see things improving once more – yet these higher ratios may understate the negative impact of Covid-19 since the start of the year, due to a weakening of covenant that many schemes will have endured but that is challenging to currently estimate.

In general, a weakened covenant can have a complicated impact on investment strategy dependent on scheme-specific circumstances. In some cases, particularly for already weak sponsors or mature schemes, it can promote de-risking. However, in other cases it may effectively shift the medium term target away from low-dependency and towards a more onerous buyout objective (given a higher chance of forced buyout in the medium term). This could promote to a higher allocation to growth assets to help close the wider gap. That said, the nature of this crisis may mean that the coming months are a sink-or-swim moment for many sponsors.

Schemes also need to remember that size of a deficit isn’t everything – and the practical manageability of a pension scheme’s deficit is dependent on several factors. This includes the strength of the sponsor, the size of the deficit relative to the size of the assets, the quality of the investment strategy, and the economic and demographic risks in the scheme.”

Christopher Jefferey, Head of Rates and Inflation Strategy at LGIM: "Investors in risk assets have been on a rollercoaster ride in the first half of the year. In sterling terms, the value of global equities fell by around a fifth in the first quarter before recovering all of that in the second quarter.

The events of 2020 serve as a good reminder that investors of all stripes need to be clear about their risk tolerance: that applies to the largest DB pension schemes just as much as to the smallest retail investors. Those investing beyond their true risk tolerance are likely to suffer from ‘path dependence’ given pressure to reduce exposure when markets are at their most volatile.

The sharp recovery in equity and credit markets has been accompanied by a further drift lower in interest rates in almost all parts of the world. The spectre of negative interest rates is now stalking the gilt market, with UK government liabilities out to 5 years’ in maturity pricing below zero during Q2. Irrespective of whether the Bank of England takes the policy rate below zero, global flows and the actions of liability-hedging investors will continue to dictate pricing at the long-end of the gilt curve."

Further information

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Adam Kirby

Associate Director

JPES Partners

T: 020 7520 7634

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Past performance is not a guide to the future.

The value of an investment and any income taken from it is not guaranteed and can go down as well as up; you may not get back the amount you originally invested.

The philosophy underlying LGIM’s approach is that schemes should focus on long-term success, defined as the assets outlasting the liability cashflows. Schemes face many hurdles to achieving this goal including covenant risk. LGIM calculated EPBM for a typical scheme as the average proportion of benefits met across the lifetime of the scheme over many different economic scenarios of the future. 

Based on the most recent Purple Book from the Pension Protection Fund, a typical pension scheme currently holds approximately 25% in equities, 60% in bonds/LDI, 5% in property and 10% in other assets. For illustration, we assume a hedge ratio of 50% of liabilities on a gilts basis and no future accrual or deficit contributions.

As at 31 March 2020, the LGIM DB Health Tracker found that pension schemes could expect to pay 91.4% of accrued pension benefits. 

Notes to editors

Established in 1836, Legal & General is one of the UK's leading financial services groups and a major global investor, with over £1.2 trillion in total assets under management* of which a third is international. We also provide powerful asset origination capabilities. Together, these underpin our leading retirement and protection solutions: we are a leading international player in pension risk transfer, in UK and US life insurance, and in UK workplace pensions and retirement income. Through inclusive capitalism, we aim to build a better society by investing in long-term assets that benefit everyone.

*at 31 Dec 2022

Legal & General Investment Management

Legal & General Investment Management is one of Europe’s largest asset managers and a major global investor, with total assets under management of £1.29 trillion1. We work with a wide range of global clients, including pension schemes, sovereign wealth funds, fund distributors and retail investors.

For more than 50 years, we have built our business through understanding what matters most to our clients and transforming this insight into valuable, accessible investment products and solutions. We provide investment expertise across the full spectrum of asset classes including fixed income, equities, commercial property, and cash. Our capabilities range from index-tracking and active strategies to liquidity management and liability-based risk management solutions.

1Globally, we manage assets of £1.42 trillion or CHF 1.75 trillion as at 31 December 2021 (source: LGIM internal data as at 31 December 2021). The data combines assets under management by LGIM in the UK, LGIMA in the US and LGIM Asia in Hong Kong. Assets under management include securities and derivatives positions.

*at 11 Jan 2023


Past performance is not a guide to the future. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, you may not get back the amount you originally invested. For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security. Views expressed are of LGIM as at 3 January 2023.


In the European Economic Area, it is issued by LGIM Managers (Europe) Limited, authorised by the Central Bank of Ireland as a UCITS management company (pursuant to European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations, 2011 (S.I. No. 352 of 2011), as amended) and as an alternative investment fund manager with "top up" permissions which enable the firm to carry out certain additional MiFID investment services (pursuant to the European Union (Alternative Investment Fund Managers) Regulations 2013 (S.I. No. 257 of 2013), as amended). Registered in Ireland with the Companies Registration Office (No. 609677).  Registered Office: 70 Sir John Rogerson's Quay, Dublin, 2, Ireland. Regulated by the Central Bank of Ireland (No. C173733).

LGIM Managers (Europe) Limited operates a branch network in the European Economic Area, which is subject to supervision by the Central Bank of Ireland. In Italy, the branch office of LGIM Managers (Europe) Limited is subject to limited supervision by the Commissione Nazionale per le società e la Borsa ("CONSOB") and is registered with Banca d'Italia (no. 23978.0) with registered office at Piazza della Repubblica 3, 20121 Milan, (Companies' Register no. MI - 2557936). In Germany, the branch office of LGIM Managers (Europe) Limited is subject to limited supervision by the German Federal Financial Supervisory Authority ("BaFin"). In the Netherlands, the branch office of LGIM Managers (Europe) Limited is subject to limited supervision by the Dutch Authority for the Financial Markets ("AFM") and it is included in the register held by the AFM and registered with the trade register of the Chamber of Commerce under number 74481231.Details about the full extent of our relevant authorisations and permissions are available from us upon request. For further information on our products (including the product prospectuses), please visit our website.