DB funding — June 2022: UK schemes near full funding

XPS Pensions Group

Deficits of UK pension schemes decreased by around £55bn against long-term funding targets over the month to 29 June 2022, analysis from XPS Pension Group's DB:UK funding tracker reveals.

The consultant said that, based on assets of £1,583bn and liabilities of £1,609bn, the average funding level of UK pension schemes on a long-term target basis was 98% as of 29 June 2022.

It said the improvement in funding levels over June added to the around £250bn reduction in deficits it had seen since the start of the year - adding that UK pension schemes were now quickly approaching full funding on a long-term target basis.

XPS said liabilities fell due to a combination of rises in gilt yields and a fall in inflation expectations. These gains were offset by schemes' hedging assets falling in tandem.

XPS Pensions Group senior consultant Charlotte Jones said: "The good news that schemes are hurtling towards their long-term targets should prompt trustees and companies to review the next steps for their schemes. With some schemes' seeing vast improvements in their funding positions, we are seeing preparations for buyout, reviewing hedging and investment strategies, or even revisiting the deficit recovery payments making their way onto schemes' agendas.

They must also not forget about the scheme members in this high inflationary environment who are likely to need more support and education from their schemes.'

DB:UK tracks the funding position of UK DB pension schemes on a long-term target basis and allows real time monitoring of changes and analysis of the reasons behind any movement.

Mercer

Mercer's pensions risk survey data shows that the accounting deficit of DB pension schemes for the UK's 350 largest listed companies at the end of June moved to a surplus over the course of the month, standing at a total surplus of £11bn by 30 June 2022.

The consultant said liabilities fell from £716bn at 31 May 2022 to £667bn at the end of June driven by further rises in corporate bond yields and a small fall in the market's view of future inflation. It said this more than offset the fact that asset values also fell, to £678bn compared to £712bn at the end of May.

Mercer UK wealth trustee leader Tess Page said: "For the first time in over three years, the month-end aggregate funding position on an accounting basis is expected to be showing a surplus, and yet again the main driver was bond yields.

"Employers and trustees will be looking to control risk, and funding improvements offer a fantastic opportunity to bank these gains. We expect that schemes will be exploring the right actions for their circumstances - ranging from a simple change in investment strategy to securing benefits with an insurance company. Those schemes with clear journey plans will be best-placed to act quickly."

Mercer's pensions risk survey data relates to about 50% of all UK pension scheme liabilities, with analysis focused on pension deficits calculated using the approach companies have to adopt for their corporate accounts. The data underlying the survey is refreshed as companies report their year-end accounts.

PwC

For the second month in a row, the position of the UK's 5,000-plus corporate DB pension schemes has increased by £60bn taking the total surplus for June 2022 to £250bn based on schemes' own measures, according to PwC's pension trustee funding index.

The consultant said that, overall, DB pensions schemes are now holding a surplus of a quarter of a trillion pounds over and above the assessment of their payout requirements. It said this is the highest surplus ever recorded by the index since it was introduced in 2014.

PwC said the increase in surplus has come about as the value of the liabilities which schemes need to cover fell over June, mainly driven by long-term bond yields continuing to rise. Asset values also fell over the month, but not by as much. So, despite market volatility in asset prices, it said pension surpluses on average continue to increase.

PwC's adjusted funding index now shows an even higher surplus at £360bn - this assessment incorporates strategic changes available for most pension funds, including a move away from lower-yielding gilt investments to higher-return, income-generating assets, along with a different approach to pre-funding potential life expectancy changes.

Global head of pensions Raj Mody said: "DB schemes reaching a record surplus this month is a stark reminder of what pension schemes are about. Assets are invested not just for the sake of it, but to cover long-term pension liabilities - and the value of those liabilities continues to reduce as long-term yields gradually rise.

"Seemingly scheme surpluses are getting bigger and bigger. However, it's important to remember that this is in aggregate - the picture is different at an individual level. While more schemes will now be in surplus, perhaps around 3,500 of them, this will range from very large surpluses to those which are more borderline."

He added: "There are about 1,500 schemes still in deficit. For many of those they will likely just need time to eliminate the deficit, as investment returns come good and prudent margins get released, instead of any additional cash payments from their sponsoring company."

Mody said that for schemes with surpluses at the smaller end of the range, it was also important that trustees and sponsors understood how their surplus has been determined, including what approximations have been made - noting that sometimes there were ‘unknown unknowns' unless you know where to look.

He explained: "The method for tracking a surplus might use an overly simplistic approach over time, presented in a glossy way through a technology portal, but actually some can be pretty rough and ready under the bonnet. Membership data could be out-of-date, benefit interpretations may not have been independently verified. There might be a disconnect between the actuarial valuation and member administration systems. Financials are volatile and some systems may not be set up to cope well with, for example, much higher than expected inflation.

"All of these issues and others could serve to rebase what looked like a comfortable surplus position into something more balanced."

PwC pensions actuary Laura Treece added that trustees and sponsors should bear in mind that they might need to use up some of their surplus if any issues come to light for their scheme.

She said: "For those looking to transfer their pension risk to a third party, we're seeing a lot of data quality concerns arise in the run up to transactions. If not addressed quickly and managed carefully, dealing with data problems can easily eat up a surplus. For example, we've been brought in to try to salvage a situation where the scheme surplus was originally estimated to be £25m, but now looks like only £5m after some data cleansing.

"Schemes that are looking to transact should plan ahead and identify any discrepancies that could push them off course. This will help them to fix things early on in the process, so they can stay on track to achieve their long-term goals."