Inflation in the UK is at a near four year high, currently standing at 2.6%. This obviously results in a reduction in disposable income for people but it also has major implications to the UK's defined benefit pension schemes.
This is because when defined benefit scheme liabilities are valued, one of the things that are taken into account is the investment markets' long-term view of inflation. With pensions generally increasing each year in line with inflation, an increase in inflation means that a higher value is placed on defined benefit pension schemes' liabilities. This, along with low-interest rates mean that the deficits of UK defined benefit pension schemes are expected to get even bigger than they are at the moment. With many already carrying serious liabilities, this can be a serious issue.
There are of course long-term consequences of enhanced liabilities. One is that employers may have to pay more into their schemes or, as is happening on a more frequent basis, many companies think that they cannot continue to support their defined benefit pension schemes and will close them to new entrants.
Under The Spotlight
Defined benefit pension scheme liabilities is something that has been thrust into the spotlight in the past year, most recently after Frank Field, the chair of the Parliamentary Work and Pensions Select Committee called into question the practice of measuring defined benefit pension scheme liabilities using the retail price index (RPI), writing to the Office for National Statistics to ask them to consider whether the use of RPI is still adequate and fit for purpose.