The recent extreme stock market volatility and failures of major financial institutions could be the final blow for the UK’s defined benefit (DB) pension funds.

DB pension schemes are already an endangered species, at least in the private sector, with the National Association of Pension Funds annual survey of its member schemes showing that only 28% of private sector DB plans are open to new members – a precipitous decline from 70% only six years ago.

UK DB pension funds operate under a system of trusteeship, where a board of amateur trustees take advice from professionals.

This means important decisions can take many months, if not years, to be made following endless meetings, consultations, reports and discussions.

Therefore it is likely any decisions over the viability of DB schemes will take time to emerge, but recent events will surely have shaken the confidence of the trustees and corporate sponsors who underwrite live DB schemes.

But even if trustees and corporate sponsors are willing to keep DB pension funds going, they could see events conspire against them.

Imagine the following scenario:

A FTSE 100 company has struggled to keep its DB scheme going for some time. With careful remedial action, the trustees have returned the scheme from a deficit to full funding in the last few years. But by the end of this year, its equity assets could be down by 10%, while lower interest rates will sharply increase liabilities, as liabilities are discounted using a risk-free rate to give a present value. This means the scheme is now massively in deficit under the ‘mark to market’ accounting rules and it requires additional funding, just as the UK economy enters recession and the employer’s profitability drops. This kind of scenario could easily lead to the remaining employers with DB pension schemes throwing in the towel.

Increasing numbers of schemes are now buying out their liabilities with insurance companies and this trend looks like continuing, with two provisos:

One is that the withdrawal of credit and risk aversion does not stop insurers from taking on long-term DB liabilities.

The second is that, following the near collapse of groups such as AIG, schemes might look twice at the security of any insurance company guaranteeing future pensions.