UK pension schemes reach record collective funding level- PwC UK

03 Oct 2022

The UK’s 5,000-plus corporate defined benefit (DB) pension schemes are now estimated to have sufficient assets to ‘buy out’ their pension promises with insurance companies, according to a new analysis from PwC. Last week’s unprecedented levels of interest rate volatility presented operational challenges for pension schemes that employ ‘liability-driven investment’ (LDI) strategies. However, when looking at the full picture of both assets and liabilities, the funding status for most pension schemes is at a strong level.

The record surplus on an insurance buy-out measure is estimated to be £155bn at the end of September, according to the PwC analysis. Insurance buy-out is typically viewed as the ‘gold standard’ for pension schemes and their members as a result of the highly regulated and secure environment that insurers operate in. The current unprecedented funding level has come about largely as a result of recent increases in long-term interest rates reducing the cost of pension buy-out policies.

PwC’s analysis also shows that these schemes collectively have a healthy surplus of £295 billion on a measure that assumes they stay attached to the corporate sponsor and invest in low-risk income-generating assets like bonds, which will generate cash flows to meet their benefit payments as they fall due over time. This so-called ‘low reliance’ situation should mean the pension scheme would be unlikely to call on the sponsor for further funding.

John Dunn, head of pensions funding and transformation at PwC, says:

“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.

“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.”

Raj Mody, global head of pensions at PwC, says:

“High pension scheme funding levels and high price inflation have generated a lot of discussion about schemes topping up pensioner benefits with discretionary increases. 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.

“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 buy-out 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."

PwC’s analysis is supported by two new DB pension funding indices launched this month to measure the aggregate funding position of the UK’s DB schemes. These reflect that schemes are increasingly focused on their long-term funding targets and how to achieve the goal of making good on the promised pension payments.

The two new pension funding indices introduced by PwC are intended to track the position of the UK’s DB schemes against two target measures:

- the Buyout Index, an estimate of the cost of insurance buyout
- the Low Reliance Index, assuming a low-risk income-generating investment strategy

The PwC Low Reliance Index and PwC Buyout Index figures for September are as follows:

£ billions,

month end

 

Asset value Low Reliance Index Buyout Index
Liability value Surplus / Deficit Liability value Surplus / Deficit
September 2022 1,425 1,130 295

1,270

155

Notes to editors:

The PwC Indices measure the aggregate funding position of the UK's defined benefit schemes. The Low Reliance Index uses a discount rate assumption of gilt yields plus 0.5% pa. “Gilts plus” measures are often collectively referred to as funding targets where there is a low level of reliance on the company that ultimately supports the scheme.

The Buyout Index reflects PwC’s view of indicative market pricing based on their current experience of completing buy-in and buy-out transactions.

PwC’s latest survey of long-term funding targets showed that around two thirds (66%) of schemes had a long-term target that was equivalent to an insurance buy-out level of funding. Almost all other schemes (33%) are targeting a level of funding that assumes that the pension scheme invests in secure income generating assets such as government and corporate bonds. With this level of funding a pension scheme would expect to be in a relatively secure position and would only need to rely on the corporate sponsor for additional contributions in a limited number of scenarios.

The PwC Indices focus on liability value measures which schemes may be targeting in the long-term. These differ from other liability value measures, for example, those used for the purposes of preparing accounting disclosures or for the calculation of the levy payable to the Pension Protection Fund.

The PwC Indices covers the whole universe of over 5,000 UK defined benefit pension funds. Some other market trackers cover just a minority subset (e.g. fewer than 10% of schemes), so may show different trends.

The estimated asset value for the UK’s defined benefit pension schemes is based on monthly data from the PPF 7800 index, tracked over each month based on the movement in asset indices using data provided by Refinitiv.

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