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Twin trouble

Inflation and deflation are back on the agenda – this month, both at the same time. The prospect of different indices pointing in different ways will present novel and complex challenges for IFAs and consumers.

The Office for National Statistics’ figures for February, out last week, showed CPI inflation increased to 3.2 per cent while the RPI index came in at zero, with most analysts expecting it to head into negative territory when March’s figures come out.

For advisers, next month’s almost certain deflation in RPI will lead to some annuity clients seeing their income actually fall for the first time in their lives.

This is not welcome news at a time when the Tories are putting pensioner inflation above 8 per cent for single retirees.

Advisers placing annuities will, for the first time, have to explain the realistic possibility of deflation eating into annuity payments when discussing indexation with their clients. Yet such is the volatile nature of the markets that they will be doing so at a time when paradoxically the biggest long term risk to pension income is perceived by many to be inflation.

Advisers will also now need to bear in mind the different approaches that different providers take to deflation.

When indexation goes negative, providers basically fall into three camps – those who will pass on deflation to annuitants in the form of reduced annuities, those whose terms and conditions allow them to do so but are waiving their right to and those which will never go into negative territory.

Standard Life, Prudential and Partnership have confirmed they will pass on deflationary cuts to some annuitants if and when RPI goes negative. Axa and LV have both said they will not pass on increases, even though their contracts allow them to. Axa has given a comprehensive commitment not to, while LV is reserving the right to review the decision in the future.

The majority of Legal & General’s customers have protection against cuts and, like Axa, it has said it will not cut rates for the small minority who do not.

For many companies, including Norwich Union and MGM Assurance, as well as a large number of the annuities held with Standard Life and Prudential, annuitants are protected by a no-decrease clause but will not see increased rates again until RPI has returned to its previous level.

This means that if the RPI index was 209.5 in March (based on a start point of 100 in 1987) it would have to rise above 209.5 before any more inflation increases were passed on to annuitants.

People buying annuities today against a backdrop of potential deflation may be encouraged towards taking the higher initial income on offer from a level annuity – those with level annuities are obviously better off if inflation remains low. But annuitants also need to bear in mind the corrosive effect inflation can have over the long term.

The reality is they probably need to hedge their bets by splitting their annuity purchase between level and escalating products.

Many economists predict inflation is the bigger threat over the long term, particularly in light of the Bank of England’s exercise in quantitative easing. If RPI deflation turns out to be a passing sideshow, it will have proved nothing more than an irritation to advisers trying to stress the importance of retirees protecting against inflation.

But if deflation stays in the system longer than expected, advisers will have to add the subject to the already complex syllabus they have to present to clients approaching retirement.

John Greenwood is editor of Corporate AdviserMoney Marketing

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