The cost of living is increasing faster than it has done at any point over the last 30 years. Official figures from the Office for National Statistics show that CPI rose by 9.4% in the 12 months to June 2022 and further increases are expected.
But what of the impact of high inflation on pension schemes? This is a checklist of things trustees (and employers) may want to think about:
Pension Increases - generally
Increases on pensions in payment are likely to be below inflation because most schemes operate a cap (or a fixed rate) that is well below current inflation levels (often 5% or 2.5%). Many schemes will have checked their indexation rules in the context of reviewing whether the right index to use to calculate increases is RPI or CPI. We recommend trustees check to see if there is a cap and how it operates.
Trustees may want to consider whether it is possible and appropriate for them to award discretionary increases. We recommend closely examining scheme rules to understand who holds any discretionary increase power and on what terms? Does it apply to all pensions in payment or only certain categories of member or tranches of benefit? Is employer consent required? Is there any role for a third party? Should the question of whether to exercise the discretion be considered each year as a matter of course (even if the decision is not to grant a discretionary increase?) What if there is a unilateral Employer power… should trustees be proactively raising this with the Employer or should their focus be elsewhere? We expect that trustees will want to consider legal and actuarial advice before exercising any power. Especially if discretionary increases are being considered for only a certain cohort of pensioners. Communication with members will also be key to ensure, for example, not to set an expectation for higher increases in the future.
Many members now take financial advice before retirement or transferring their benefits (and indeed may well be required to do so). It may be that, after financial advice, members decide to reconsider when they take their pension (see below about the possible impact on retiring early).
It may be that schemes start to see an increase in member enquiries / complaints – perhaps from disgruntled members whose pension has decreased in real terms or who cannot retire when they wanted to. Trustees should ensure their Internal Dispute Resolution Procedure is to hand and is ready to send out if requested.
Early Retirement Factors
Trustees must set early retirement reductions that are of equal value to the pension at normal retirement age. With inflation so high, should trustees change early retirement factors to ensure equal value compared to the benefit being given up at normal retirement date? We are aware that scheme actuaries are considering some or all of the following:
- an early retirement increase;
- a lower early retirement reduction;
- no reduction;
- no reduction for the last year of pensionable service only;
- no change (because, in the ordinary course the appropriateness of factors is constantly changing and trustees won’t necessary change factors for every change in market inputs or assumptions and/or early retirement factors are not necessary increased in periods of super low inflation).
We recommend reviewing the early retirement rule for what it says about how early retirement factors are calculated and how the Scheme has been amended to comply with preservation requirements. There is an interesting question for those whose scheme’s rules describe an early retirement “reduction”; particularly as the preservation requirements are not overriding.
Funding Levels and Investment Strategy
Depending on their asset mix and the extent to which they have hedged inflation risk, some schemes will have seen their funding position improve. We expect other schemes will be reviewing their inflation hedging in light of the expected prolonged period of high inflation.
Many people are currently watching their personal budgets. There is much for pension scheme trustees to be thinking about too. For all trustee decisions flowing from the high inflationary environment, we recommend trustees take appropriate advice and carefully document their decision making.
The Consumer Prices Index (CPI) rose by 9.4% in the 12 months to June 2022, up from 9.1% in May.