DB funding - Sept 2022: PPF index shows record surplus for schemes on s179 basis

PPF

The aggregate surplus of the 5,215 schemes in the PPF 7800 index is estimated to have increased over the month by £60.7bn to £374.5bn at the end of September 2022, from £313.8bn at the end of August 2022, the Pension Protection Fund (PPF) says.

The PPF said the funding ratio increased from 125.1% at the end of August 2022 to 134.8% at end September.

Assets totalled £1,450.5bn and liabilities amounted to £1,076.0bn, compared to £1,565.0bn and £1,251.2bn at the end of August 2022.

It said there were a total of 746 schemes in deficit and 4,469 schemes in surplus - noting the aggregate deficit of the schemes in deficit at the end of September 2022 was £5.3bn, down from £14.3bn at the end of August 2022.

PPF chief finance officer and chief actuary Lisa McCrory said: "Last month was likely to have been very challenging for many DB schemes operationally. However, we expect that the impact of rising gilt yields will have had a positive impact on scheme funding, and that over 80% of schemes are now fully funded on our s179 basis with a combined deficit of just over £5bn, down from £14bn at the end of August.

"We anticipate that many schemes will have seen a change in their hedging positions. While DB liabilities have fallen, a high interest and inflation environment could put further pressure of some employers. It is important that trustees understand how their funding and risk profile has changed and have contingency plans in place."

The PPF said its 7800 update was produced using its standard methodology. It said this would capture the impact of government bond yield increases on the liabilities but that the impact on assets will be less accurate.

The lifeboat fund said this was because it did not hold sufficient data to capture the impact of any structural changes to asset allocations made to meet collateral calls over the month nor did it have sufficient information to accurately capture changes in any leveraged liability-driven investment (LDI) portfolios.

Reaction

Broadstone senior actuarial director Jaime Norman said that, as expected, the aggregate liability value has fallen significantly over the last month due to the jump in long dated gilt yields over the month of September.

But he agreed there were uncertainties around this month's figure. Norman said: "Whilst the reported surplus has risen, we might expect this to be adjusted downward once data becomes available on LDI funds, which make up a significant proportion of UK pension scheme assets."

Standard Life senior business development manager Rhian Littlewood said that, despite the pressure on LDI strategies the funding position of most schemes had approved - noting that a number of additional factors were currently coming together to improve the funding position of schemes as sponsors step up deficit funding, technical provisions improve, and investment performance has generally been positive in recent years.

Littlewood said: "Although we expect volatility in this uncertain economic climate, this improved funding position has made insurance more affordable for many schemes and the possibility of a buyout seem closer than in previous years, opening up new opportunities for schemes to pursue derisking activity.

"The competitive insurance landscape is also providing attractive levels of pricing due to the recent rise in gilt yields, and we anticipate that schemes will be looking at how they may be able to lock in this opportunity."

Mercer

The accounting surplus of DB pension schemes for the UK's 350 largest listed companies decreased to £5bn at the end of September, analysis of Mercer's Pensions Risk Survey data shows.

The consultancy said liabilities fell from £657bn at 31 August 2022 to £605bn at the end of September driven by rising corporate bond yields. It said asset values also fell over the period to £610bn compared to £666bn at the end of August, which reduced the impact of the liability falls.

Mercer UK wealth trustee leader Tess Page said: "The aggregate funding position on an accounting basis has been incredibly volatile during September, soaring to a surplus of over £100bn last week, before settling at a surplus £5bn at the end of September.

"The catalyst was in gilt markets - notably a surge in yields after the UK chancellor's Mini Budget was announced on 23 September, which increased speculation of further interest rate hikes to curb inflation amid expectations of increased government borrowing."

Mercer said that, with many pension schemes prudently managing inflation and interest rate risks with LDI mandates, many schemes faced stress tests on the collateral levels needed to support these investments.

It said the Bank of England stepping in to stabilize the market to a degree, but many schemes were still urgently sourcing cash to shore up collateral buffers.

With the headlines focusing on gilt yields, inflation has gone somewhat unnoticed, but by the end of the month there had been a significant rise in future implied inflation expectations, which is currently at its highest level in a decade.

Page added: "There will be schemes that were forced sellers of assets, and funding positions will have been sorely tested.

"To add to trustees' headaches, the current situation could potentially have implications on the covenant strength of some employers, and their ability to pay contributions, as higher interest rates will mean that borrowing becomes more expensive at a time where they are also facing rising costs and global supply chain issues."

She said: "It is crucial for trustees and employers to take stock of where they are and consider what future scenarios may unfold, and what contingency plans are in place through their integrated risk management frameworks, to manage risk."

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.

XPS Pensions Group

UK pension schemes' funding positions have increased by around £94bn over the month to 29 September 2022 against long-term funding targets, XPS Pensions Group's DB:UK funding tracker reveals.

The consultant said, based on assets of £1,451bn and liabilities of £1,363bn, the aggregate funding level of DB pension schemes on a long-term target basis was 106.5% as of 29 September 2022.

XPS said that, following the chancellor's Mini Budget on 23 September the market had seen the biggest swings in gilt yields in recent times - with yields closing the month having risen by 0.8 percentage points.

It said rising gilt yields continued to be the main contributor to improvements in funding levels during September with the continued fall of long-term inflation expectations further improving the situation.

The consultant said this added to the improvements in long-term positions seen over 2022 - now in excess of £410bn for the year.

And it said that, despite equity and credit markets struggling over September, with most schemes not being fully hedged the increase in gilt yields will have led to funding positions improving, especially compared to their longer-term targets.

XPS Pensions Group head of investment Ben Gold explained: "The last week will long be remembered for the Bank of England intervening to stabilise the gilt markets. The impact on pension schemes has been considerable.

"Strategically it's been hugely positive as funding positions have significantly improved. But operationally it's been very challenging as schemes have tried to ensure their liability driven investments remain sufficiently collateralised, and many are still assessing the impact. It is expected that hundreds of schemes will have had their hedging reduced to some extent.

"This is likely to lead to some permanent changes to LDI funds and how liability risks are hedged in future. That said, we shouldn't forget the huge improvement in funding position many schemes have seen. Quantifying that and considering how they react to that should be a key focus of attention for schemes."

XPS 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.

PwC

The UK's 5,000-plus corporate DB pension schemes are now estimated to have sufficient assets to buyout their pension promises with insurance companies, latest analysis from PwC reveals.

The professional services firm said, while last week's unprecedented levels of interest rate volatility presented operational challenges for pension schemes that employ LDI strategies, the funding status for most pension schemes was at a strong level.

PwC's analysis comes as it launches two funding indices to replace its existing scheme-specific and adjusted measures, which it discontinued in June. The two indices track the position of the UK's DB schemes on buyout and low-resilience measures.

PwC's buyout index estimates of the cost of insurance buyout reflects the consultant's view of indicative market pricing based on its current experience of completing buy-in and buyout transactions. The firm's low reliance Index, assumes a low-risk income-generating investment strategy of gilt yields plus 0.5% per annum.

It estimated surpluses were £155bn on a buyout measure and £295bn on a low-reliance measure at the end of September.

PwC head of pensions funding and transformation John Dunn said: "The current funding position for UK DB pension schemes highlights that, despite unprecedented economic and market volatility, schemes are actually in good health overall. Now the question is whether there's enough insurance gold to go around or, just like the real thing, is it a scarce resource?

"Seemingly, the insurance market does not have the capacity for all of the schemes who can now afford to buyout, to make this a reality any time soon. There could be over £1trn of assets chasing perhaps £50bn of annual capacity in the insurance market - the maths just doesn't stack up."

Dunn added: "What we are likely to see is more schemes rushing to get ready to join the insurance buyout queue. Others will contemplate running off over the longer term, either as stand-alone schemes or consolidating with others, rather than buying out with insurers."

PwC global head of pensions Raj Mody said high scheme funding levels and high price inflation had generated a lot of discussion about schemes topping up pensioner benefits with discretionary increases - but he said little of this talk had translated into action so far.

Mody explained: "Pension scheme members are understandably concerned - most pension schemes cap inflation increases on benefits to 5%, yet the cost of living is going up faster than that. However, in practice, actually applying discretionary increases to pensions remains a minority activity so far.

He said: "Of the few schemes where we are seeing some consideration of discretionary top-ups, there are usually bespoke scheme-specific circumstances at play which would not apply more widely.

"It might be an extremely well-funded scheme; for example, one well in excess of its insurance buyout cost, with comfortable surplus funds and a strong sponsor. It might be because there's some kind of ‘end-game' transaction happening, such as a buy-in or buy-out, and there are spare funds to share out between members and the sponsor. Sometimes, it might be down to historical legal ambiguities which mean the trustees feel the pressure to exercise their discretion. Although we are seeing several cases under discussion, it's currently a very small number relative to the 5,200 defined benefit schemes in the UK."