On the go: Pension schemes already suffering the funding implications of Covid-19 could be facing a further £5bn of pressure, as the prospect of deflation later in the year produces a “ratchet effect”, according to analysis by LCP.
Modelling the level of inflation according to three separate economic scenarios – “stuck in the doldrums”, “steady as she goes”, or enjoying a “bounce back” – the company found that, absent a strong economic recovery, both the consumer price index and the retail price index could fall into negative figures by September, with the former potentially reaching 2.8 per cent.
While LCP notes that the impact on individual schemes will vary on a case-by-case basis, largely depending on the extent to which pensions in payment are index-linked to inflation, as well as the approach taken to hedging pension increases, a significant hit to pension schemes that use RPI cannot be ruled out.
The report explained that changes in RPI, forecasted to fall to minus 0.8 per cent even under a “steady as she goes” recovery, would amount to a 0.8 per cent increase in the real cost of benefits. With around £800bn in index-linked DB benefits in payment in occupational pension schemes, that would amount to £5bn in additional costs.
Jonathan Camfield, partner at LCP, said: “Ultra low interest rates and market volatility have already weakened the funding position of many schemes, but negative inflation could add a further financial burden.
“Schemes generally cannot reduce pensions in payment even when prices are falling, resulting in a real-terms increase in the cost of providing pensions,” he explained.
“We anticipate that this could add at least £5bn to long-term scheme costs and the burden on their sponsoring employers as deflation is expected to be experienced in the economy over the coming months.”
