Research from fiduciary manager Van Lanschot Kempen has highlighted potential risks facing UK defined benefit (DB) pension schemes, with scenarios ranging from a UK debt crisis to a US balance sheet crisis and a US/China strategic conflict over Taiwan.
According to the research, a UK debt crisis could lead to a 7% fall in funding levels of UK DB pension schemes and an increase of £4 million in deficits per £100 million of liabilities for well-funded schemes.
Conversely, lower-funded schemes may experience a marginal increase in funding levels.
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A US balance sheet crisis presents even greater challenges, it stated, with an 8% drop in funding levels and deficits increasing by £9 million per £100 million of liabilities for well-funded schemes.
A US/China strategic conflict, followed by an escalation of tensions in Taiwan, would see well-funded UK DB pension scheme funding levels fall by 4% and deficits increase by £5 million per £100 million of liabilities.
Medium and lower-funded schemes could face even greater impacts, with funding levels predicted to drop by 12% and 16% respectively, and deficits increasing by £14 million and £20 million.
Alistair Greenlees, head of investment strategy at Van Lanschot Kempen, pointed out that the International Monetary Fund’s latest assessment advised against further UK tax cuts until debt levels decline, while warnings of a return to “bond vigilantism” have emerged from parts of the financial services sector.
“Such an event has the greatest impact on UK gilts and credit and is a larger risk for well-funded ‘de-risked’ schemes – high corporate credit holdings (which most schemes de-risk towards) present a risk if not carefully managed,” said Greenlees.
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Less well-funded schemes may see a modest benefit due to lower liability hedges and limited use of credit assets, however, those with higher leverage could face dual shocks, including liquidity constraints, added Greenlees.
Calum Edgar, investment strategist at Van Lanschot Kempen, added: “The specific risks faced by schemes will be dependent on funding levels and asset allocation, the approach to liability hedging, credit quality and equity exposure.
It is crucial to have a partner who can effectively communicate risks and adapt techniques as the market evolves, providing schemes with diversification, discretionary-led portfolio dynamism and explicit downside risk management strategies.”
