DB schemes with ‘clean bill of health’ before pandemic

However, the rosy figures are expected to take a sharp downturn for those pension schemes with valuations coinciding with the pandemic outbreak.

According to analysis conducted by Aon of the UK pension schemes’ funding valuations completed up to July 2020, the average technical provisions funding levels and the proportion of schemes in surplus were both higher than for any previous year since the start of the current funding regime.

The outbreak of Covid-19 had a significant impact, with March 2020 being a low point. In view of this, schemes with tranche 15 valuations may consider making adjustments to allow for post-valuation experience

Aon

The Pensions Regulator will be keen to note the increased uptake by schemes with tranche 14 valuation dates of long-term objectives and long-term funding targets, which the watchdog encouraged in light of the requirement in the pension schemes bill that plans set out a strategy ensuring benefits can be paid in the long term.

Sixty-seven per cent of schemes covered by Aon’s study had a long-term funding target in addition to a technical provisions target. This is a 7 per cent increase over the figure for tranche 13 valuations. Moreover, more than half of schemes were expecting to reach their long-term funding objective within 10 years. 

Aon’s report notes: “Though a revised code will not be in force until December 2021, based on the regulator’s current timescales, these statistics indicate that trustees and employers understand the importance of setting a long-term objective, and that they are anticipating the likely changes to the funding regime.”

Covenant strength a determiner of risk exposure

With TPR also stressing the importance of integrated risk management in its code of practice, the news that 74 per cent of schemes have now adopted such an approach is bound to be welcome. In tranche 11, that figure stood at 53 per cent.

Yet the report also shows how the strength of employer covenants correlates with the amount of hedging — for instance against interest rate risk and inflation — that schemes undertake. 

Those with weaker covenants are less likely to report being fully hedged, a phenomenon meaning that the financial impact of the lockdown falls harder on those least able to afford it.

However, the evidence also suggests that schemes with weaker covenants are less likely than their counterparts to report not having or only moderately hedged, attributed in the Aon report to schemes adopting an integrated approach.

In total, 85 per cent of schemes with tranche 14 valuations reported having hedged at least 70 per cent of both their interest rate and inflation risk.

Funding levels (were) in good shape

“The average funding level for valuations in tranche 14 was 93 per cent, and 37 per cent found the scheme to be fully funded on the technical provisions basis. Both of these measures were higher than for any previous tranche,” the report finds.

The average funding level for tranche 14 was two per cent higher than tranche 13, and the percentage of fully funded schemes was five per cent higher.

However, the report notes that significantly increased assets and liabilities accrued since tranche 11 mean that “a typical scheme’s deficit in monetary terms would not have reduced to the extent that might be suggested by the change in the average funding levels”. 

The situation for underfunded schemes also saw an improvement. The average length of recovery plans for schemes with tranche 14 valuations was down 2.7 years compared with tranche 13, falling to 4.5 years. 

A more direct comparison is between tranches 14 and 11, when many of the former had their last valuation. Such a comparison shows that the average length of recovery plan was down 2.2 years, which the report characterises as “a bigger reduction than might have been expected over three years, after allowing for schemes that moved from deficit to surplus and therefore no longer had recovery plans”.

Here again the strength of the employer covenant at least correlates with performance, however. Aon’s report shows that, where the trustees of schemes felt their covenant to be ‘weak’ or ‘tending to weak’, the average length of a recovery plan was 7.1 years, three years longer than pension funds where trustees estimate their covenant as being ‘strong’ or ‘tending to strong’.

“The difference in average recovery periods suggests that affordability remained a significant factor in setting recovery plans in tranche 14,” the report notes, and affordability “was considered a constraint on deficit reduction contributions for 48 per cent of schemes in deficit in tranche 14”.

Enter the virus

Of course, much of the preceding has been superseded by events. Taking recovery plans and deficit repair contributions as a case in point, Pensions Expert reported in July on analysis by TPR showing that the government’s Covid-inspired lockdown could necessitate on average a 75 per cent hike in DRCs if schemes were to maintain their current recovery plans.

The regulator’s analysis showed that “fewer than 15 per cent of schemes would be able to retain their DRCs at the same level or less, while around 20 per cent would need to increase DRCs to more than three times their current level”. 

It was also reported in August that the accounting deficit of the DB schemes of the UK’s 350 largest listed companies increased to £103bn at July 31 from £90bn at the end of June, while liability values saw a similar increase, rising to £950bn from £937bn over the same period.

Aon’s report states: “Since the dates of these [tranche 14] valuations, average funding levels improved and then dipped significantly following the outbreak of Covid-19, before partially recovering.

“For valuations in tranche 15, those with effective dates at the end of 2019 will look quite different to those in March or April 2020,” the report continues.

“By the end of 2019, funding levels had improved further from the historic highs in tranche 14. However, the outbreak of Covid-19 then had a significant impact, with March 2020 being a low point. In view of this, schemes with tranche 15 valuations may consider making adjustments to allow for post-valuation experience.”