Inflation the likes of which we have not seen in over a generation is evident, as are its effects. But recent reports suggest, oddly enough, that inflation is not bad for pension plans in every respect.
Members vs plan sponsors
According to Oct. 3, a further worsening of inflation will hurt the value of pensions held by pension plan participants and retirees, as well as their purchasing power. “The annuity adds unique exposure to inflation,” they say, whose consumer price index rises directly by reducing the value of fixed dollar annuities.
But so far, says Oct. 3, inflation has had “no direct effect” on pension plan sponsors. Further, future inflation could actually reduce pension costs for plan sponsors, as it would reduce the cost of nominal income and the value of claims for it.
October 3 says inflation actually improved pension plan liability figures, if the Federal Reserve raises interest rates in response to continued price increases. Similarly, the CIO’s blog calls higher interest rates a “boon” to pension plans for this reason. This, they explain, is because with higher rates, plans don’t need to set aside as much money to fully fund their retirement obligations since the value of the payments plans have to make in the future is smaller.
Lesser pension plan liability leads Sweta Vaidya, head of solutions design at Insight Investment, to expect insurers to charge lower rates to cover these plans, the CIO blog reports.
Investments and allocations
Rising interest rates and rising prices could also change how plans allocate funds and make investments, both October Three and the CIO Blog claim. October Three expects inflation to affect the stock market and the bond market, and suggests that plan sponsors want to consider how inflation and interest rates will affect their strategies for their portfolios. Similarly, the CIO blog notes that Vaidya suggests that higher interest rates may mean different allocation strategies.
In addition, according to the CIO blog, higher interest rates are affecting liability-driven investing and could cause private sector pension plans to shift from stocks to bonds. And Vaidya predicts that the improved capitalization will likely spur further risk reduction, possibly through bonds.