UK firms' pension deficit to rise after inflation verdict

By Sarah Mortimer

LONDON, Jan 17 (Reuters) - Top British firm's pension scheme liabilities will rise about 20 billion pounds ($32 billion) after a decision not to alter how the country's oldest measure of inflation is calculated, consultant Mercer said.

Mercer said on Thursday the news had led to a rise in the cost of inflation swaps - the financial tools that are used to hedge pension risk.

Last week, the Office for National Statistics opted against making changes to the retail price index (RPI), a measure used to calculate workplace pension payouts to the retired, saying it would create a new index using improved statistical techniques.

Most economists had expected RPI to be changed to make it more similar to the consumer price index (CPI), which is targeted by the Bank of England and, typically, is significantly lower than RPI because of different statistical techniques.

If changes had been made to RPI, it would have cut pension deficits by around a quarter, pension industry analysts said. For Britain's FTSE 350 firms, this would have meant a 30 billion pound reduction in pension scheme liabilities.

Instead, inflation swap rates rose up to 0.4 percent.

Pension funds have already been hammered by weak economic growth and repeated rounds of central bank easing, which have contributed to a sharp drop in yields on British government bonds, making it more expensive for funds to match income to liabilities, unless they add riskier, higher-yielding assets.

"Inaction has meant an increase in market implied inflation which has increased pension scheme liabilities by around 20 billion pounds," said Ali Tayyebi, senior partner and head of defined benefit risk at Mercer.

Final salary-linked pension deficits doubled to 231 billion pounds last year, according to the Pension Protection Fund.