UK defined benefit pensions survey 2023

Headline results from the survey are as follows:

• 93% of schemes in our survey have seen their asset base reduce over the last 12 months as a result of falling bond and LDI prices;
• however, we estimate that at the end of September 2023, the 5,000 plus corporate defined benefit pension schemes in the UK had a combined surplus on an insurer buy-out basis of £215 billion;
• 10% schemes saw their funding levels fall, largely as a result of issues with interest rate hedging strategies during last Autumn’s LDI Crisis;
• 30% of schemes have now surpassed their long-term funding target;
• gilts + 0.5% is the most common long-term funding target;
• 3 out of 10 schemes have updated their long-term funding target in the last 12 months;
• locking in improvements in funding and improving asset liquidity are the main focuses of schemes’ investment strategies;
• only a third of schemes consider themselves to be Fast Track compliant.

Our survey documents the dramatic effect that the LDI Crisis had on UK defined benefit schemes. Asset bases have fallen dramatically, yet, paradoxically, due to the way liabilities are valued, funding levels for most schemes have improved. These very high funding levels bring forward decisions that many schemes did not expect to have to make for a decade or more. For example, should they buy-out the benefits with an insurance company or ‘run-off’ as a standalone scheme?

The LDI Crisis had a profound effect on the asset base of the UK’s defined benefit pension schemes - 93% of schemes in our survey have seen their asset base fall over the last 12 months

Long-term interest rates started to rise at an increasing pace over the second half of 2022. As a result, assets with values linked to interest rates, for example, bonds and LDI, fell in value.

The impact has been felt by defined benefit pension schemes that typically hold a significant proportion of their assets in bonds and LDI.

Our survey reveals that over the last 12 months:

• 93% of schemes saw a fall in the value of their assets;
• over half of pension schemes saw their asset value fall by 20% to 40%; and
• only 7% of schemes have seen an increase in their asset value.

The spread of outcomes reflects the differences in investment strategies followed by schemes, including the level of ‘gearing’ employed in the LDI strategy.

Despite the fall in asset values, the collective funding position of the UK’s 5,000 plus defined benefit pension schemes has never been as strong

The chart below shows the change from deficit to surplus of the UK’s 5,000 plus defined benefit pension schemes as measured by the PwC Buy-out Index and the PwC Low Reliance Index.

A buy-out deficit of over £600bn in October 2021 has rapidly changed to become a surplus estimated to be over £200bn.

Similarly, on a ‘gilts plus 0.5%’ low reliance measure of these pension schemes’ liabilities, a deficit of around £200bn is now estimated to be a surplus of around £360bn.

This improvement in funding levels is largely driven by a fall in the assessed value of liabilities due to rapidly rising long-term gilt yields.

We conclude that collectively the UK’s defined benefit pension schemes have never been better funded. As a result, many pension schemes will have to address issues they did not expect to have to contemplate for a decade or more. A key one being whether to buy-out with an insurer or ‘run-off’ as a standalone scheme.

Whilst the majority of schemes saw an improvement in funding, 1 in 10 saw their funding level fall

Despite funding levels generally increasing, 10% of schemes saw their funding level fall over the last 12 months.

Why was this?

Experience suggests that these were the schemes that had difficulties maintaining their hedging arrangements through the LDI Crisis this time last year. Either they found their assets were too illiquid to sell to meet increasing LDI collateral requirements or they missed collateral calls due to operational issues with posting collateral.

As a result they lost their hedging arrangements as interest rates spiked in September and then again in October 2022. This loss of hedging was detrimental to funding levels.

30% of schemes surveyed have now reached their long-term funding target and are in surplus on this measure

Given the improvement in funding levels over the past 12 months, we are not surprised to find that 30% of schemes surveyed are now in a position where they have exceeded their long-term funding target. This compares to only 10% of schemes in last year’s survey.

As we have noted, the question is then ‘what next?’ for these schemes.

Reaching a long-term funding target suggests that a scheme is in a position to buy-out with an insurer or lockdown risks and run-on for a number of years in a low reliance on the employer state.

The implementation of a successful buy-out looks very different to a low reliance run-off in terms of: cost, risks, stakeholder value, and crucially the investment strategy that the scheme will adopt.

In a separate recent PwC poll, 40% of respondents indicated that even if their pension scheme was fully funded on a buy-out basis they would choose to run-off.

Liabilities calculated on a ‘gilts plus 0.5’ measure is the most common long-term funding target for pension schemes

The 2022 PwC Long-Term Funding survey found that a gilts plus 0.5% measure of the liabilities was the most common long-term funding target; and we find the same result this year.

This is not surprising. The UK pensions industry has settled on gilts plus 0.5% as a reasonable low reliance funding target. In addition, the UK Pensions Regulator has indicated that gilts plus 0.5% will be its Fast Track requirement for a low reliance funding target.

32% of schemes are adopting a gilts based long-term funding target that is more conservative than gilts plus 0.5%; either gilts plus 0.25% or gilts flat. In terms of strength, these targets are not that different from a buy-out level of funding for many schemes in current market conditions (and could be more conservative for a number).

31% of schemes surveyed have changed their long-term target over the last 12 months. This may reflect significant improvements in funding positions over this timeframe or resetting a target to match the expectations of the Pensions Regulator.

Investment strategies are under review and schemes are focusing on locking into improved funding and improving the liquidity of assets

It is not surprising given the events of last Autumn that schemes are reviewing investment strategy.

Our survey highlights two key areas of focus: schemes want to lock in funding gains made; and they also want to improve liquidity.

Which assets schemes lock in to will depend on which end game solution they adopt. An investment strategy that is aiming to reduce the risks of a near term insurance transaction could look very different to a run-off strategy.

The Regulator’s proposed Fast Track funding regime is designed to make complying with scheme funding regulations easier - a third of schemes consider themselves to be Fast Track compliant

The draft requirements of the Regulators’ proposed Fast Track funding regime include:

• a gilts plus 0.5% low dependency funding basis;
• duration based technical provisions that are set as a percentage of the low dependency liabilities and duration based maximum asset and liability stress tests;
• maximum recovery plan lengths of no more than 6 years prior to a duration of 12 years and 3 years at shorter durations;
• deficit reduction contributions can increase by no more than CPI;
• asset and liability post valuation experience can be allowed for when setting recovery plans; and
• no allowance for investment outperformance can be made in the recovery plan.

We expect the Pensions Regulator to finalise its funding code of practice and FastTrack compliance regime in the Summer of 2024.