XPS’s DB:UK funding tracker reveals:
- Scheme deficits against long-term funding targets fell by around £72bn over the month to 31 December 2021.
- The average funding level of UK pension schemes was 86%.
- 2021 was a volatile year for UK pension schemes with aggregate deficits reaching as high as £392bn and as low as £228bn over the year, with a net annual reduction in deficits of £26bn.
- It will currently take nearly 12 years to reach long-term targets under the proposed new rules from The Pensions Regulator, an increase of two years from the position at the start of 2021.
Deficits of UK pension schemes have fallen by around £72bn over the month to 31 December 2021 against long-term funding targets, an analysis from XPS’s DB:UK funding tracker has revealed. Based on assets of £1,895bn and liabilities of £2,205bn, the average funding level of UK pension schemes on a long-term target basis was 86% as of 31 December 2021.
Drivers of change
This change in December was largely driven by a rise in gilt yields following the Bank of England’s announcement that it was increasing base rates from the historic low of 0.10% to 0.25% on 16th December. This is a welcome improvement from the position at the end of November when deficits peaked at nearly £400bn due to Omicron, political uncertainty, and high inflation expectations.
Tom Birkin, Actuarial Consultant, XPS Pensions Group, said: “The Bank’s decision to increase interest rates despite the emergence of Omicron is not unexpected given significant inflation pressures, and the resulting rise in gilt yields is welcome news for sponsors of pension schemes after a difficult November. With uncertainty over inflation and Omicron persisting, sponsors and trustees should be braced for further volatility in 2022.”
Throughout the pandemic, equity markets have shown surprising resilience to bad news. The worst day for equity markets this year arrived following the emergence of the new Omicron Covid-19 variant (the FTSE100 down 3.6% over 26 November), but markets have recovered strongly to reward equity investors with another healthy positive return over the quarter. This concludes a strong year for equity markets as a whole with returns in the region of 20%. As a result, many well-hedged pension schemes have seen further improvement in funding. Markets will continue to be concerned about inflationary pressures as they were throughout 2021, and investors in the UK economy will hope that the recent base rate increase will provide some stability going forwards.
Hedging strategies in place for pension schemes have delivered on their role of reducing volatility, with interest rates and inflation taking it in turns to push up liability values.
Felix Currell, Senior Investment Consultant, commented: “With such significant movement in interest rates and inflation, the precision of hedging strategies will have been stressed over the year. This may have introduced some misalignment and we would recommend that trustees review their current hedge exposure to ensure it remains in line with their target”.
Looking over 2021, rises in gilt yields and positive asset growth battled against spiking inflation. Whilst the average scheme’s position has improved, the impact on each scheme will differ markedly depending on the chosen investment strategy.
Impact on pension scheme members
XPS estimates that at the end of 2021, the average pension scheme would need an additional £29,000 of funding per member to ensure it can pay their pensions into the long-term.
While this may concern members, pension schemes are working hard to reduce deficits via Employer contributions and positive investment returns in line with Regulator guidance.
Furthermore, the recent growth in inflation will mean that members whose pensions increase in line with inflation will be better placed than most to handle the predicted higher cost of living in 2022.
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