Inflation risk and pensions: Should we worry?
We address the topical issue of inflation risk in the pension sector. Currently inflation risk is borne by pension participants, who are typically inadequately informed of its potential impact. We outline how inflation risk should be incorporated into the current risk models. To understand and measure the impact of inflation risk, suitable modelling tools – such as a versatile simulation engine – are needed. We have developed such a simulation engine, which demonstrates that a less defensive investment strategy than is currently typical for a pension fund – i.e., with a larger allocation in real assets (such as value stocks) – offers a natural inflation hedge and hence leads to superior pension results in real rather than nominal terms.