Pension deficits in DB schemes grew by 5.1 per cent in the first three months of 2020, as a result of market falls.
This figure was calculated by the Legal & General Investment Management’s DB Health Tracker, which shows the overall financial health of this sector deteriorated over this period.
LGIM found that the average DB scheme can currently only expect to pay 91.4 per cent of accrued pension benefits as of March 31 2020. This is down from 96.5 per cent at the end of December 2019.
LGIM’s head of solutions research John Southall says: “The 5.1 per cent fall was mainly attributable to a fall in the value of return-seeking assets due to Covid-19.
“A typical scheme is also under-hedged on rates and inflation risk so the fall in gilt yields led to an increase in nominal liabilities relative to their hedging assets. Real yields were broadly flat, however, due to a commensurate fall in expected inflation.”
This quarterly analysis, which takes into account the risk that a sponsor might default and the impact that would have on scheme’s members, found that 8.6 per cent of accrued pension benefits would not be paid on average across potential scenarios. This compares to just 3.5 per cent in December 2019.
He adds that this measure has been volatile, due to the current market environment. “As the situation evolves we will update our estimate, as experience since 31 March has generally been positive. However as the negative impact of the crisis on typical covenant strength becomes clearer, we will also look to incorporate this into our figures.
“Schemes with significant allocations to credit may be able to help close these gaps by moving towards more cashflow matched strategies if they haven’t already done so, as well as increasing their rates and inflation hedging levels.”
Southall adds that a number of factors determine how manageable a pension scheme’s deficit is, not just its size. 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.
LGIM head of rates and inflation strategy Christopher Jeffery adds: “The first quarter delivered exceptionally weak returns across a broad range of risk assets.
“The coronavirus pandemic, and the associated shutdown in economic activity, has led to a sharp reappraisal of expectations for both earnings growth and default risks. Global equity markets dropped by a third from their mid-February peak and spreads on major corporate bond indices widened by over 250 basis points.
“Despite the pending deluge of government bond supply to fund stimulus programmes, yields dropped sharply as central banks cut interest rates and reactivated bond purchase programmes.”
He adds that equity and credit markets served up a lesson that volatility was only hibernating during recent years. The benefits of diversification in managing that risk become most apparent in such difficult conditions.