UK pension funds look to hedge against falling inflation

UK pension funds are looking at inflation structured products in order to hedge the risk embedded in pension liabilities they pay at retirement, amid a falling inflation environment. Pension fund liabilities are adjusted for Limited Price Indexation (LPI) which is the Retail Price Index (RPI) but capped at 5% and floored at 0%.

"Pension funds have left the 0% floor and the 5% unhedged on the basis that the RPI has never reached 5% or fallen below 0%," says Kara Lemont Sportelli, London-based head of interest rate and FX structuring at BNP Paribas. "But these funds have risk if inflation is negative because they will have to grow those pension liabilities at 0%, where their inflation hedge is going to be negative. Therefore they are looking at notes which pay a coupon rate which embeds a floor on the RPI at 0%."

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