Wealth manager Van Lanschot Kempen has modelled the impact of five potential risk scenarios relevant to UK defined benefit (DB) pension schemes, assessing their effects on funding and deficit levels per £500 million liabilities.
The funding levels of well-funded UK DB pension schemes may fall by 4%, with deficits increasing by around £19 million per £500 million of liabilities if the ‘Magnificent Seven’ technology bubble bursts this year, according to the estimates. Similarly, a potential Eurozone sovereign debt crisis may result in funding levels falling by 4% and deficits increasing by £24 million per £500 million liabilities.
In the middle of ‘stagflation’ concerns in the UK, the modelling has shown that well-funded UK DB pension schemes would experience a 4% fall in funding levels, with deficits increasing by £13 million per £500 million of liabilities. However, this scenario may prove beneficial for medium and lower funded schemes, according to Van Lanschot Kempen, with funding levels projected to increase by 3% and 5%, respectively, with deficits predicted to fall by £32 million and £65 million per £500 million of liabilities.
A “sudden and significant decline in the stock prices” of the seven largest technology companies, referred to as the ‘Magnificent Seven,’ may lead to well-funded UK DB pension schemes’ funding levels falling by 4% and deficits increasing by £19 million per £500 million of liabilities, according to the estimates.
A sharp downturn could lead to substantial market volatility, eroding investor confidence and triggering broader economic repercussions, according to the data. Lower-funded schemes, often exposed to riskier assets, would be hardest hit, experiencing a fall in funding levels by an estimated 11%, with deficits increasing by £61 million per £500 million of liabilities.
Alastair Greenlees, head of investment strategy UK at Van Lanschot Kempen, commented: “UK DB pension schemes have benefitted from rising gilt yields over the past few years that have left many sitting pretty in surplus. However, our research has shown that schemes must remain vigilant to the significant tail risk events that continue to pose a potential threat in the market. This is particularly important for the UK DB sector, where strong funding levels could easily be undermined by unexpected external risks, especially as many schemes begin to consider their strategic endgame options.”
The research has also forecast a decrease in well-funded UK DB pension schemes’ funding levels by 4%, with deficits increasing in the potential event that a Eurozone country defaults on its sovereign debt. A debt crisis could trigger falling interest rates and wider corporate credit defaults, prompting investors to rush to safe-haven assets, which would drive down yields on UK gilts and increase the present value of pension liabilities. Lower-funded schemes would experience deficits rising by £56 million and £85 million per £500 million of liabilities.
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The latest UK growth figures present a concerning outlook, with the Bank of England halving its growth forecast to 0.75% for this year. Concerns around rising unemployment and inflation have led to fears of UK stagflation. The findings have shown a divergence in the impact on schemes in such an event.
For well-funded schemes, funding levels could fall by 4% due to widening corporate credit spreads negatively impacting bondholders. In contrast, for medium and lower-funded schemes, rising gilt yields are expected to lead to an increase in funding levels by 3% and 5%, with deficits falling by £32 million and £65 million per £500 million of liabilities.
The UK government’s proposed reforms for the DB sector, focusing on increasing investment in ‘productive UK assets’ and mechanisms for extracting surpluses, remain under discussion. The analysis showed that even in an extreme scenario where UK DB schemes are mandated to invest up to 10% of their assets in productive UK assets, funding and deficit levels are unlikely to be significantly impacted.
Donald Trump’s plans for heavy tariffs could impact global markets and stoke reinflationary concerns, according to the model. Well-funded schemes could see a slight uptick in their funding status, with deficits falling by £20 million per £500 million of liabilities. However, if inflation surpasses 5%, schemes holding index-linked gilts may face mismatches in their liability-driven investment strategy. Alternatively, a Trump presidency boosting economic growth and global markets could benefit all schemes, with lower-funded schemes benefiting the most due to their higher allocation to riskier assets.
Calum Edgar, investment strategist at Van Lanschot Kempen, commented: “The analysis underscores the importance of considering individual scheme situations and tailoring risk management approaches accordingly. In a period during which we are seeing the UK pensions industry undergo significant change, trustees must be armed with bespoke solutions designed to meet the needs and circumstances specific to their schemes in order to ensure resilience against adverse events while maintaining a path for their members’ long-term security.”
