The UK is currently seeing soaring inflation, with record drops in wages, and prices for goods and services sky-rocketing, resulting in a keenly-felt "cost of living" crisis. But what is the impact for UK occupational pension schemes?

The consumer price index (CPI) measured inflation at 9.1% at the end of May 2022, the highest level seen since February 1982. Governments have traditionally sought to counter rising inflation by increasing interest rates, to encourage people to spend less and save more, as recently seen in the Bank of England decision to increase the base rate from 0.1% to 1.25%. With inflation expected to continue rising this year, below-inflation pension increases look set to become the norm, but does this accord with trustee fiduciary duties? At the very least, some consideration of the impact on schemes is likely to be needed. We explore further the impact of high inflation and interest rates on pension schemes below.

The ultimate effect of rising inflation is that, in real terms, defined benefit scheme (DB Scheme) members are likely to be worse off. For the past 30 years, DB Scheme members have largely been protected from inflation rises as private sector DB Schemes often increased and revalued benefits in line with inflation. However, these increases have historically been capped and fall well below the soaring rate of inflation, now eroding this protection. Accordingly, trustees of DB Schemes may wish to review the impact on their members and communicate where necessary to make members aware of this issue, and any measures proposed to address it.

Sponsors of DB Schemes should also review which index is being used to value inflation. Many DB Schemes started out using the Retail Price Index (RPI), an index which the Office for National Statistics has encouraged a move away from, but have switched to the CPI where the RPI was not hard-coded into scheme rules. The CPI is typically a lower rate and the difference between the indexes currently stands at around 2%.

As inflation rises, trustees of DB Schemes and their sponsoring employers may come under pressure from members to award discretionary increases in excess of those provided for under scheme rules. It is unlikely that such increases are required by the rules of DB Schemes but, where a scheme is operating in surplus, it may be hard for sponsoring employers to decline at least to consider the request. Of course, any requests for discretionary increases under DB Schemes operating in a deficit will be far less likely to succeed.

When setting early retirement factors, legislation requires trustees to be "reasonably satisfied" that the total value of an early retirement benefit is at least equal to the total value of the member's normal retirement benefit. This is generally considered over the scheme as a whole and updated from time to time as market conditions change. Conditions here in the UK have now changed sufficiently that trustees are likely to need to consider adjusting early retirement factors ahead of normal review dates, to ensure they remain "reasonably satisfied" this is the case.

The current funding of DB Schemes

However, the situation is not all doom and gloom. Deficits are broadly down in the current economic environment. XPS Pensions Group's DB:UK funding tracker reports that UK DB Scheme deficits against long-term funding targets decreased by around £56 billion over the month of June. While the deficits of DB Schemes are decreasing overall, despite the challenges faced by a challenging economic climate, there may be delay in seeing the full impact of increased interest rates and inflation. Sponsoring employers may well still be slow in considering granting discretionary increases and could reasonably decide to adopt a longer-term, more cautious outlook.

The effect on defined contribution schemes

Defined contribution schemes (DC Schemes) are not immune from the effect of rising inflation. Members of DC Schemes may see the value of their pension pot (and therefore their purchasing power for retirement annuities) falling as they approach retirement. Members who contribute a set percentage of salary may be protected from the dangers of high inflation, where that salary increases in line with inflation. In practice, this is unlikely to be the case for many workers, particularly those in the public sector. As a result, sponsoring employers and trustees of DC Schemes may wish to consider seeking and providing guidance to members regarding default investment strategies and other potential investment options to try to mitigate this. Individual members should similarly consider obtaining independent financial advice when considering changing their investment options, or before seeking to access benefits.

Potential solutions

A variety of methods can be used by schemes and trustees as a potential solution to rising inflation and interest rates, such as de-risking.

One such method is incentive exercises. This typically involves either:

  • an enhanced transfer value (ETV) exercise, where members are offered an uplift to their benefits, in return for transferring a cash sum for their DB pension to another (usually defined contribution) pension scheme; or
  • a pension increase exchange (PIE) exercise, where members give up certain future non-statutory increases to their benefits, in return for a higher initial pension.

It is certainly the case that most, if not all, schemes should be undertaking a member communication exercise to highlight member options. This would simply involve writing to members to outline what benefit options they have under the scheme, and advising members to consider these options well in advance of retirement – in practice, members are far more likely to take up one of the options available after a communication exercise. This can often be helpful to smaller schemes approaching buy-out.

Buy-ins are another de-risking option, increasingly used as a way of reducing funding risk. This essentially involves the trustees securing benefits under an insurance policy that covers a specified proportion of a scheme's liabilities. A premium is paid to an insurer in exchange for guaranteeing that proportion of the scheme's liabilities. This can be used to de-risk scheme liabilities in uncertain times. However, trustees should carefully consider which specific scheme liabilities they want to cover, in order for this to be an effective de-risking practice.


Whilst adopting a "wait and see" approach may prove effective for some trustees, with the Bank of England projecting that inflation will continue to rise, trustees and sponsoring employers of both DB and DC Schemes should be making preparations and reviewing the impact on their scheme. Member communication exercises and early retirement factor reviews will be critical tools for at least partially addressing the impact of this current economic climate on pension schemes.