11 Feb 2020
Pension scheme health improves in Q4 – LGIM Defined Benefit Health Tracker
The overall health of defined benefit (DB) pension schemes improved in Q4 2019, according to Legal & General Investment Management (LGIM). Its DB Health Tracker - a monitor of the current health of UK DB pension schemes – has found that a typical DB pension scheme1 could “expect” to pay 96.5% of accrued pension benefits as at 31 December 2019, in their “expected proportion of benefits met” (EPBM) metric.
The 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 3.5% of accrued pension benefits would not be paid on average across their scenarios.
How manageable a pension scheme’s deficit is depends on a number of factors, 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.
There was an overall increase in our EPBM metric for a typical scheme of around 2.8% during Q4 2019, compared to the previous quarter. This was mainly driven by an increase in interest rates and positive asset performance over the period.
When global recession risks receded over Q4 2019, Gilt yields rose more than US and German government bonds as Hard Brexit fears dissipated. In 2019, we saw structural downward pressure on long-dated UK inflation when comparing it to the US equivalent. In Q4, this contributed to 30-year index-linked Gilt yields rising approximately 0.4%, one of the biggest three-month increases in the last decade.
GBP strength from October onwards detracted from growth assets exposed to overseas currencies and, in turn, will have hurt marginal demand to de-risk, as fewer schemes reach the position to do so. The impact on Sterling would have cancelled out most of the Q4 gain on global equities for an unhedged UK investor.
With Brexit risks now perceived as more balanced, a key question for defined benefit schemes is whether to retain the overseas currency exposure that hurt their funding levels in Q4 but cushioned the blow back at the time of the 2016 Brexit referendum. Generally, in the risk management of our own multi-asset portfolios, we retain significant overseas currency exposure, in part to help benefit our investors in scenarios where the UK suffers a negative shock and their job security or sponsor security might fall.
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.
1 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.
2 As at 30 September 2019, the LGIM DB Health Tracker found that pension schemes could expect to pay 93.7% of accrued pension benefits.
Notes to editors -
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 £1.1 trillion1. We work with a wide range of global clients, including pension schemes, sovereign wealth funds, fund distributors and retail investors.
Throughout the past 40 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.
1LGIM internal data as at 30 June 2019. These figures include assets managed by LGIMA, an SEC Registered Investment Advisor. Data includes derivative positions.