Headlines

• CPI reached 9.1% in the 12 months to May 2022, the highest level since 1992, and is on course to reach 11% later this year.  RPI was 11.7%. 
• In response to rising inflation the Bank of England has increased base interest rates five times in the six months to June 2022, from 0.1% p.a. to 1.25% p.a. 
• Long-term nominal and real gilt yields have followed suit, increasing by around 1.5% p.a. over the first half of 2022.
• Further yield moves will depend on whether there are more, or less, interest rate rises than currently priced into the market, alongside investor’s longer-term expectations of growth, inflation, and interest rates.
• That increase in expectations for the path of interest rates has led to pressure on equity valuations, with global equities down more than 10% to end-June. Credit spreads have significantly widened year to date. Considerable uncertainty in the outlook remains.

10 key actions

Against this backdrop, there are 10 actions that trustees and sponsors should be considering now:

1. Assess and monitor the impact on scheme funding. The impacts for individual schemes will be varied depending on the exposure to growth and credit markets and the extent of interest rate and inflation hedging in place, but liabilities could have reduced by around 25%. With market volatility likely throughout 2022, it is important to be alive to changes.
2. Manage liquidity for LDI collateral calls. Review your plan for meeting future capital calls to ensure sufficient liquid assets are available should yields increase further.
3. Refresh your liability hedging benchmark so it's up-to-date for changes in market conditions and scheme experience. 
4. Review the level of target hedging. Consider whether the market movements create an opportunity to increase your hedge level at attractive long term interest rates, particularly if you were holding back on hedging until gilt yields went up.
5. Revisit asset allocations and any need for rebalancing. Review whether asset allocations might have drifted out of line versus target and consider rebalancing. It may be a good time to review your investment strategy and the outlook for expected returns / risk in the current environment to lock-in gains or look for ways to reduce risk.
6. Assess any impact on your employer covenant from factors such as higher inflation and energy prices and increased borrowing costs, particularly if the employer has limited ability to pass these onto customers in response.
7. Review discretionary pension increase powers. Inflation this year will exceed most fixed increases and inflation “caps”. Review discretionary powers, policies, and historic practices, bearing in mind that trustees and sponsors might face growing pressure to revive these.
8. Consider communications to members and prepare for queries, including potential complaints from pensioners.
9. Check approach to early retirements, since deferred members are likely to be surrendering a currently higher rate of revaluation for lower annual increases in payment. Schemes should consider early retirement reductions to make sure they reasonably reflect the benefits being given up, and could also consider the information they provide to members.
10. Review commutation factors and terms for other options such as pension increase exchange since these are often fixed for periods of time. A shift in yields of c1% will typically reduce cash commutation factors by around 20% at retirement.  

To find out more download our checklist.

For further information, or to discuss any of the issues raised in this checklist, please speak with your usual Hymans Robertson consultant.