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Firms in financial trouble could be allowed to reduce the generosity of pensions, the government has suggested.

As part of a discussion paper on the future of Defined Benefit (DB) pensions, it said financially "stressed" companies might be allowed to water down previous promises.

About 5% of businesses are in that category, according to the green paper.

As many as eleven million people are members of private sector DB schemes, which link pensions to salaries.

In particular, some companies might be allowed to adjust the way they up-rate pension payments annually to compensate for inflation.

Instead of using the Retail Prices Index (RPI), it could be that some companies would be allowed to use the Consumer Prices Index (CPI) instead, the government said.

Since CPI is usually lower than RPI, it would save firms money.

However, such a change could cost the average pensioner up to £20,000 over the course of their retirement, according to the discussion document.

Most public-sector Defined Benefit pensions schemes moved to the CPI measure in 2011.

Image copyright Getty Images Image caption Public sector pensions, like the NHS scheme, already use CPI to up-rate payments

Steve Webb, who was a pensions minister under the Coalition government, said allowing such a change would be worrying.

"There is a significant risk that relaxing standards on inflation protection - with the best of intentions for exceptional cases - could be exploited and lead to millions of retired people being at risk of cuts in their real living standards," he said.

In the paper, the government also raises the idea of temporarily suspending any sort of inflation indexation at all, when pension schemes are in serious trouble.

Yet it admits this could raise "moral hazard issues", whereby companies might be tempted to deliberately increase their deficits to save money on pension pay-outs.

Shrinking deficits

Most DB pension schemes remain "affordable" for employers, the government said, even though most are currently in deficit.

So the government's message to employers is unequivocal: most can clear their pension deficits if they want to.

It said the total deficit of all DB schemes in January 2017 was £197bn, down from £459bn in August 2016.

"Our modelling suggests that these deficits are likely to shrink for the majority of schemes, if employers continue to pay into schemes at current/promised levels," the paper declares.

"While DB pensions are more expensive than they were when they were set up, many employers could clear their pension deficit if required."

DB schemes have declined over recent years, as employers have switched to more affordable defined contribution (DC) schemes, where pension payouts are linked to investment returns.

The pensions industry is now being asked to comment on the ideas in the green paper.