Inflation hedges elude insurers as UK consumer prices rise
Inflation hedges are eluding insurers selling bulk annuities as consumer prices increase. UK inflation is predicted to hit nearly 3% by the end of the year, threatening to hit insurers that have to hedge large books of inflation-linked liabilities. Many pension liabilities are tied to the consumer price index (CPI) rather than the retail price index (RPI). Hedging instruments for CPI are more challenging, meaning insurers are forced to take on basis risk.

UK inflation looks set to reach nearly 3% by the end of 2017, according to estimates from Fitch Ratings – a disquieting prospect for UK insurers that sell bulk annuities and have to hedge big books of inflation-linked liabilities.

While inflation risk is not explicitly recognised within Solvency II's standard model, the expectation is that insurers using an internal model will hold capital against the risk of an increase.

At the same time, close matching of assets and liabilities to enable firms