For many of us, the COVID-19 pandemic has had a real impact, ranging from inconvenience through to the loss of a loved one. What kind of affect has the pandemic had on defined benefit (“DB”) pension schemes?
The obvious starting point is longevity. With all the headlines of doom and gloom that surround COVID-19, are we seeing an excess number of deaths?
Firstly, it’s worth highlighting that while the effects of the pandemic have been devastating on the health of many, it is mortality rates (the rate of death in a population), not morbidity rates (the rate of disease) that matter. In particular, it is those who had underlying health conditions (and a lack of means to protect themselves) and the very elderly who have been most at risk of death. Indeed, in 2020 mortality rates were more than 10% higher than expected.
Secondly, the real question to ask is, how has your own specific pension scheme been affected? For example, recent data has shown that the effect of the pandemic has not been uniform across the UK.
Impact upon funding
While it may seem harsh, the cold hard fact of the matter is that where deaths have taken place amongst the elderly and/or those who lacked the means to protect themselves (i.e., typically those receiving lower pensions), the impact on DB schemes will have been relatively minor. Total liabilities will have remained broadly unchanged, as the liability for each of the aforementioned groups will have been relatively low.
Indeed, we expect the reduction in liabilities due to COVID-19 related deaths to be negligible compared with the impact of financial markets. This can be seen by looking at the Pension Protection Fund’s 7800 Index, which shows an aggregate deficit of nearly 5,500 DB schemes. At the end of January 2020, prior to the pandemic hitting, the deficit stood at £74.7bn. By the end of March 2020, that figure had increased to £135.9bn, before falling back to £78.8bn by November 2020. The vast majority of this volatility derived from changing market conditions.
While the initial impact of the pandemic on DB pensions was a hit to scheme funding levels as financial markets crashed, we have seen funding positions continue to improve over the past year or so, such that the buy-out market is increasingly busy. Rising gilt yields (resulting in a lower value placed on liabilities) and increases in asset values have placed buy-out within reach of many schemes and their sponsors.
This has inevitably led to an increasing focus on the “end-game” - either because it has come within reach, or because sponsors are keen to avoid any repeat of the volatility that was seen during 2020.