Pensions - Articles - MetLife on Defined Benefit Schemes and Inflation Risk

 

  
•    Inflation is now seen as the 6^th most important risk out of 18 by trustees and plan sponsors. It is the 5^th most important for trustees, compared to 14^th in 2010. This was the biggest jump for any of the 18 risks
  
•    The top 5 risks are funding deficits; employer covenant; asset and liability mismatch; meeting investment return targets; and longevity risk    
  
•    37% of trustees and pension sponsors said that inflation was important in 2011, compared to 25% in 2010
  
•    In terms of which of the 18 risks pension trustees and sponsors are most successful at managing, inflation came in at 13^th (out of 18) in 2011
  
•    MetLife says that  the increases for this risk factor among trustees is likely directly tied to the Government’s proposed replacement of the Retail Prices Index (RPI) in favour of the Consumer Prices Index (CPI) as the basis for determining statutory pension increases
  
•    Trustees, grappling with the implications of this statutory change on their members’ benefits, may have spent a significant amount of time and attention trying to determine whether future increases should be based on CPI or RPI. Trustees may have also had to communicate with members about this statutory change since CPI, which has historically been lower than RPI, could potentially lead to a reduction in benefits for members
  
•    Regardless of the index used, inflation has been exceeding the Government's targets on a fairly regular basis, which is very worrisome to trustees
 

 Uncertainty over the switch from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI) for indexation of benefits and persistently higher than expected inflation in the wider economy has dramatically increased the importance defined benefit (DB) pension scheme trustees and sponsors place on inflation risk, research from MetLife Assurance reveals.

  

 According to the 2011 UK Pension Risk Behaviour Index (PRBI), trustees and sponsors now rank inflation risk as the 6^th most important risk out of 18 risk factors facing their schemes. The most significant shift was seen among trustees, with Inflation Risk moving up in the importance rankings from 14^th most important risk in 2010 to 5^th in 2011. However, the number of times Inflation Risk was selected as important when it was presented to respondents is virtually identical among both sponsors (38%) and trustees (37%). Overall, it was selected as important 37% of the time in 2011 compared with 25% in 2010.

  

 Compounding this, latest CPI inflation figures reveal a rise from 4.2% in June to 4.4% in July. 

  

 The results of the 2011 UK PRBI reveal that trustees may be placing greater importance on Inflation Risk because of the significant amount of attention given to inflation since the Government’s announcement of the proposed move to change statutory indexation to CPI from RPI in July 2010. However, the greater importance ascribed to Inflation Risk has not yet been matched with success in managing it. Trustees’ success ranking for this risk held its 12^th place year on year.  This is only slightly ahead of scheme sponsors’ success ranking which dropped slightly from 13^th in 2010 to 14^th in 2011.

  

 Following further announcements and a consultation on the proposals, a statement from Pensions Minister Steve Webb confirmed there will be legislation to prevent CPI having to be used as an underpin for schemes which use RPI and ruled out legislation forcing schemes to change to CPI from RPI.

  

 Emma Watkins, Director of Business Development, MetLife Assurance Limited said: “Trustees and sponsors are rightly concerned about the risk of inflation. Whilst we welcome the Government’s statements that a CPI underpin will not be required as it would have increased complexity and cost, it will not be until legislation is enacted that the uncertainty faced by trustees and sponsors over the past year will be removed.

  

 We encourage trustees and sponsors to meet regularly to review ways to manage the full spectrum of risk factors faced by their schemes and to understand which risks need to be prioritised in the short, medium and longer terms. Frequent meetings ensure that both groups can shift their focus in response to economic, regulatory and demographic changes.”

  

 The 2011 UK PRBI, released in May 2011, shows that schemes are increasingly more focused on funding-related risks, with the top three risks ranked as Funding Deficits, Employer Covenant and Asset and Liability Mismatch.