When does high inflation become a good thing?
This paper analyses the positive impact that inflation increases could have on a real-life pension scheme. It looks at the impact on the scheme's funding level of both step changes across the entire inflation curve and short-term inflation shocks and explores how best to find the scheme's 'tipping point' – the point at which further inflation becomes beneficial for schemes.
This paper explores how best to find the scheme's 'tipping point' – the point at which further inflation becomes beneficial for schemes...
Inflation is costly for pension schemes up to the 'tipping point', after which further inflation could be beneficial for schemes.
- How do increases in inflation affect funding
Each member's benefits will typically be increased annually with reference to inflation. The higher inflation and inflation expectations, the higher the liabilities. Schemes' asset values may also increase due to rising inflation. When there is a change in inflation expectations, there is an immediate market value impact for asset types with an explicit link to inflation.
- Finding the tipping point: a case-study example
This paper consider in detail the impact that increases in inflation can have on the funding levels of a real-life scheme illustrating where the scheme's 'tipping point' lies.
- But what about inflation shocks?
It is also a useful exercise to consider what the impact would be of short-term inflation shocks on a pension scheme. For our case-study, the 'shock tipping point' is also determined.
Both step changes to inflation expectations and short-term inflation shocks impact schemes, and 'tipping points' can be determined under both scenarios. Trustees and sponsors should aim to have a thorough understanding of the impact of inflation risks on their schemes.
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