Bond yields lift funding levels for U.K. corporate pension plans

The total surplus of U.K. defined benefit funds covered by the Pension Protection Fund's 7800 index rose 58.8% in December, to £129.3 billion ($174.4 billion), thanks to rising bond yields that saw fewer plans in deficit.

That compares with a surplus of £81.4 billion at the end of November, and is a marked improvement from one year earlier, when the PPF reported a deficit of £86.4 billion at the end of December 2020.

The PPF is the lifeboat fund for defined benefit plans of insolvent U.K. companies. It covers 5,215 pension funds, of which 2,152 are in deficit and 3,063 are in surplus.

The funding ratio grew 3.1% in December to 107.7% from 104.6% at the end of November. The aggregate deficit was £97 billion, down from £125.9 billion the previous month. One year earlier, the funding ratio was 95.5%.

For pension funds in surplus, the total surplus increased to £226.3 billion at the end of December from £207.3 billion the previous month, and from £143.9 billion the previous year. The 3,063 pension funds in surplus at the end of December compares with 2,112 one year earlier, and represents 58.7% of plans, compared with 39.7% in December 2020.

Pension funds covered by the PFF had £1.82 trillion in assets and £1.69 trillion in liabilities. Assets decreased 1.3% over the previous month and 0.9% over the year, while liabilities decreased 4.1% over the month and 12.1% over the year.

According to the December 2021 PPF 7800 index report, equity markets and gilt yields are the main drivers of funding ratios. "The value of scheme assets is affected by the change in prices of all asset classes, but owing to the volume invested and the volatility, equities and bonds are the biggest drivers behind changes — bonds have a higher weight in asset allocation, but equities tend to be more volatile," the report said.

Lisa McCrory, PPF's chief finance officer and chief actuary, in a statement noted the positive effect of bond yields on funding surpluses, but added, "the unpredictable fluctuations in the 7800 funding ratio over the past few months are a clear sign of the ongoing market volatility and the need for caution."

Sion Cole, BlackRock managing director and head of U.K. fiduciary business, echoed that caution. "We expect to see continued volatility in the market," Mr. Cole said in an emailed statement.

"2022 has started with a unique combination of events — the economic restart; uncertainty surrounding the new omicron virus strain; supply-driven inflation; and new central bank frameworks — with no historical parallels. Cutting through this is a challenge, and pension scheme trustees will be better positioned to succeed by ensuring they have proper scenario risk management practices in place," he said.

The PPF's 2021 Purple Book, the latest data and analysis of the pension funds it covers, shows that the average allocation to equities fell to 19% from 20.4% in 2020, while bonds rose to 72% from 69.2%.

Within bonds, index-linked bonds increased to 47.2% from 46.1%, corporate bonds increased slightly, 28.2% from 28%, and government fixed-interest bonds fell to 24.6% from 25.9% a year earlier.

Within equities, U.K.-listed ones fell to 11.6% from 13.3% the previous year, while non-U.K. ones decreased to 68.3% from 69%. The proportion of private equities increased to 20.1% in 2021 from 17.7% in 2020.

The switch to bonds highlights a decadelong trend to derisk assets, BlackRock's Mr. Cole said, but "considering all macroeconomic factors in a whole portfolio context, we believe pension funds should also constructively consider a focus on hedging liabilities to help weather the year ahead."