The Upside of Inflation?

Inflation the likes of which we haven’t seen in more than a generation is obvious, as are its effects. But recent reports suggest— strange though it may seem—that inflation is not harmful in every respect for retirement plans. 

Participants vs. Plan Sponsors

Further worsening of inflation, says October Three, will hurt the value of annuities held by pension plan participants and retirees, as well as their spending power. “Annuitization adds a unique inflation exposure,” they say, which consumer price index increases directly reducing fixed-dollar annuities’ value.

But so far, says October Three, inflation has had “no direct effect” on pension plan sponsors. Not only that, future inflation actually could cut pension-related costs for plan sponsors because it would reduce the cost of nominal income and the value of claims for it. 

Liabilities 

October Three says that inflation actually improves pension plan liability figures, if the Federal Reserve raises interest rates in response to continued price hikes. Similarly, the Chief Investment Officer blog calls higher interest rates “a boon” to pension plans for that reason. This, they explain, is because with higher rates plans do not need to set aside as much money in order to fully fund their pension obligations since the value of payments the plans must make in the future is smaller. 

The lower liability pension plans face leads Insight Investment Head of Solution Design Sweta Vaidya to expect insurers to charge lower rates to cover those plans, the CIO blog reports. 

Investments and Allocations

Rising interest rates and rising prices also could change how plans allocate funds and make investments, both October Three and the CIO blog say. October Three expects that inflation will affect the stock market and the bond market, and suggests that plan sponsors may want to consider how inflation and interest rates will affect their strategies for their portfolios. Similarly, the CIO blog notes that Vaidya suggests higher interest rates may spell different allocation strategies. 

Furthermore, says the CIO blog, higher interest rates affect liability-driven investments, and could result in private-sector pension plans moving from equities to bonds. And Vaidya anticipates that improved funded status probably will spur further risk reduction, possibly through bonds.