DB members could lose £25,000 to inflation increase caps

It was reported on September 14 that inflation had fallen slightly, sitting at 9.9 per cent compared with the 10.1 per cent registered in July, albeit this is still near 40-year highs. 

Short-term estimates disagree on the future direction of price rises. Citigroup warned on August 22 that inflation could increase to as much as 20 per cent in January, though economists from Barclays and HSBC separately suggested that inflation may have already peaked at 10.1 per cent, in part dependent on the impact of a government energy price freeze. 

Pensions increases tend to track short-term inflation calculations. XPS Group has previously suggested that members considering retirement should delay their decision until early in 2023, when they could — scheme rules permitting — benefit from an additional inflationary increase equating to around a 7 per cent difference, or more than £10,000 of extra pension income over the members’ lifetime, when compared with a member who retires at the end of 2022.

It warned, however, that schemes would have to review their early retirement factors to ensure members are offered fair value in light of the high inflation rate.

Some schemes are able to award discretionary increases above the cap, typically set at around 5 per cent, though Aon estimated in June that the cost of awarding discretionary increases could be as high as £18bn, up from the £8bn mooted in May.

XPS has now warned that inflationary caps could see members lose as much as £25,000 over a lifetime, and urged those schemes that are able to consider how they can further support their members, and whether they can award increases above the cap.

It said that despite the boost to funding positions due to rising interest rates, long-term inflation expectations have still added £100bn to scheme liabilities since July.

Pension increases are, however, based on short-term measures, with the retail price index now at 12.3 per cent and the consumer price index showing 9.9 per cent.

Caps of 5 per cent or lower preclude members’ pensions rising in line with inflation, meaning that the average pensioner in a private sector DB scheme could lose around £1,200 a year over the next two years, resulting in £25,000 of lost income over the lifetime of a pensioner at the state pension age of 66.

XPS Pensions Group actuary Tom Birkin said: “For current pensioners, sustained periods of high inflation will compound the effects of pensions not keeping pace with rising prices.

“Pension schemes should explore options to support their members through this challenging period. Those who are able should consider whether they can provide financial support to their members, via additional increases to pensions above the caps in place.”