A bursting of the ‘Magnificent Seven’ tech bubble and a Eurozone sovereign debt crisis are the largest potential risks to defined benefit (DB) schemes in the UK, according to modelling from Van Lanschot Kempen.

Assessing the impact of several potential risk scenarios, the investment manager estimated that well-funded UK DB schemes would see their funding levels fall by 4 per cent and their deficits rise by around £19m per £500m of liabilities if the ‘Magnificent Seven’ technology bubble bursts this year.

In this event, a sharp downturn could lead to “substantial” market volatility, which would erode investor confidence and potentially trigger broader economic repercussions, including impact on other risk-on assets, resulting in lower market liquidity and a push for quality assets.

Lower-funded schemes would be hardest hit as they are often exposed to riskier assets, and could see funding levels drop by 11 per cent and deficits increase by £61m per £500m of liabilities.

Meanwhile, a potential Eurozone sovereign debt crisis could result in well-funded DB schemes’ funding levels falling by 4 per cent and deficits rising by £24m per £500m of liabilities.

The modelling found that a debt crisis could trigger a fall in interest rates alongside wider corporate credit defaults, leading to investors rushing to ‘safe-haven assets’ that would drive down UK gilt yields and increase liabilities.

Medium and lower-funded schemes could see their deficits rising by £56m and £85m respectively per £500m of liabilities in this scenario.

Van Lanschot Kempen also assessed the potential impact of growing ‘stagflation’ and found that well-funded DB schemes would experience a 4 per cent drop in funding levels in this event, with deficits rising by £13m per £500m of liabilities, due to a widening of corporate credit spreads.

However, this scenario could prove beneficial for medium and lower-funded schemes amid rising gilt yields, with funding levels projected to increase by 3 per cent and 5 per cent respectively, and deficits predicted to fall by £32m and £65m respectively per £500m of liabilities.

“UK DB pension schemes have benefitted from rising gilt yields over the past few years that have left many sitting pretty in surplus,” commented Van Lanschot Kempen head of investment strategy UK, Alastair Greenlees.

“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.”

Van Lanschot Kempen investment strategist, Calum Edgar, added: “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."

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