The Office for National Statistics (ONS) has announced that the Consumer Prices Index (CPI) increased by 6.2 per cent in February 2022, which could present ‘challenges’ to defined benefit (DB) pension trustees as inflation expectations rise.

XPS Pensions Group noted that future inflation expectations could rise again due to the CPI announcement, with its DB:UK Funding Watch finding that £140bn has already been added to liabilities of DB schemes since the final lockdown rules were removed on 19 July 2021.

Furthermore, the consultancy warned that, as inflation had increased by more than 5 per cent for three consecutive months and most pension increases are capped at 5 per cent a year, increases on pensions had started to “lag behind” price inflation.

XPS warned that these below-inflation pension increases will “be felt by pension scheme members who continue to be squeezed by the rising cost of living”.

“The impact of soaring inflation has been felt right across the pensions industry, with rising inflation expectations adding to schemes’ liabilities and creating challenges for trustees as they work toward long-term funding targets,” commented XPS Pensions Group actuarial consultant, Tom Birkin.

“It’s not all bad news for pension schemes, however, as the Bank of England’s recently announced hike in interest rates will have had a positive impact on liabilities and will work to counteract inflationary pressures to some extent.”

Adding to this, Hymans Robertson cited concerns that the current high levels of inflation could knock DB schemes' endgame strategies off track if trustees and sponsors do not fully understand the impact of inflation on their portfolios.

"This increase in prices is likely to be further exacerbated by the Ukraine invasion and the resulting inflationary impact of the crisis," said Hymans Robertson head of corporate DB end game strategy, Leonard Bowman.

"Not only will this add growing pressure on the cost of living and lead to an expected increase in interest rates throughout 2022, this level of inflation could dramatically shift the UK pensions investment landscape.

“The impact of high inflation on the financial management of a DB pension scheme can be complex and if this is not properly understood and acted upon then endgame strategies designed to secure members’ benefits may be knocked off track, meaning higher costs and longer timeframes before financial targets are achieved.”

Hymans Robertson co-head of DB investment, Ross Fleming, added: “With Chancellor’s Spring Statement taking place against a backdrop of a higher-than-expected inflation rate, it is vital that DB trustees ensure that they fully understand the potential impact of inflation on their scheme.

"This will provide enough time to allow for a review of the scheme’s approach to inflation hedging, or assessment of how to position the its asset strategy to guard against persistently high inflation before it becomes too late.

“As we have emerged from the Covid-19 pandemic the ongoing recovery has led to a significant increase in inflation across the world. This compiled with the ongoing war in Ukraine, a drive towards responsible investment and ongoing volatility in energy prices has created a unique environment that schemes must be prepared for.”

Aegon pensions director, Steven Cameron, noted that the 3.1 per cent increase in the state pension in April 2022 is exactly half the 6.2 per cent rise in inflation, leaving state pensioners “one step forward but two steps back, undoubtedly leaving many severely stretched”.

“It’s clear that lower income households and pensioners are disproportionately affected by inflation rates higher than seen for 30 years,” he added.

“That’s why it’s crucial that in future, as planned, inflation data is refined to show the effect on different household categories.”

Canada Life technical director, Andrew Tully, warned that, as inflation is tipped to reach 8 per cent by the mid-year, “the worst is yet to come”.

“How long inflation remains well above the 2 per cent target will determine our real living standards for years to come. Especially for pensioners whose personal rate of inflation may be well above the headline rate,” he commented.

“While the government has restated their commitment to the state pension triple lock, any rise reflecting the current high inflation will only take effect from April 2023, which offers little in the way of comfort for those pensioners struggling to make ends meet today.”

Analysis of the Bank of England’s Inflation Calculator by Hargreaves Lansdown found that someone retiring in 2000 with a pension of £100,000 would need £179,000 if they retired at the end of 2021 to maintain their purchasing power.

It warned that pensioners were particularly at risk from the impact of inflation as they live on pensions and savings that would have accumulated over their working lives and may need to last them 20 years or more.

“Pensioners with annuities could see their income increase if they opted for an inflation-linked product, otherwise their income remains flat regardless of what inflation does,” noted Hargreaves Lansdown senior pensions and retirement analyst, Helen Morrissey.

“If you decide annuities are the right retirement income product for you then it is often a good idea to annuitise your pot in slices over a period of time rather than doing the whole pot in one day as you risk locking into low annuity rates that you cannot amend later.

“Income drawdown can be useful as being invested in the markets means your pension has a better chance of keeping up with inflation. However, care needs to be taken to ensure the income withdrawn remains sustainable over the long term. Taking large amounts out early in your retirement may cause problems later if your investment returns can’t keep pace and you risk eating into your capital.

“It is better to adopt a natural yield strategy where the amount of income you take is no more than the investment returns your pension generates. There will be times when you have to take less than you need but having a cash buffer will enable you to ride out any short-term bumps. Taking a flexible approach will help your retirement income remain resilient in the face of inflation.”

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