Removing the wedge

  • By: Hannah Brenton
  • 27 Sep 2012
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A trolley at a Sainsbury's supermarket

Hannah Brenton looks at how a change to RPI could improve scheme funding by billions of pounds.

The Office for National Statistics launched a consultation on changes to the Retail Prices Index formulae last week, following an investigation by the statistical body’s Consumer Prices Advisory Committee into the “formula effect gap”. The consultation is likely to be watched closely by the pensions industry, as even a small change to the way RPI is measured is likely to have a significant impact on scheme funding.

The ONS consultation is a response to concerns that the way RPI is calculated keeps it artificially higher than its counterpart the Consumer Prices Index, which has been lower for most of its history. RPI is predominantly calculated using an arithmetic mean, while CPI uses a geometric mean. RPI has historically been between 0.5% to 1% higher than CPI.

The national statistician Jil Matheson will launch a consultation on 8 October with four reform options on the table. These range from keeping the formula effect in place, reducing its effect, removing it to a minimum, or removing it entirely. Any of the three latter options would bring RPI more in line with CPI, meaning it would be lower. The consultation will close on 30 November, with any changes to be announced in January and come into effect in March 2013.

A big change

Experts say schemes should anticipate a change. Punter Southall technical director Joanne Livingstone says the second-least extreme option on the table, where the calculation would remove clothing from the formula effect, would still make a sizeable difference to the index.

She says: “Even the clothing one is significant because the research shows that clothing is quite a lot of the formula gap, so there’s a big change in RPI coming.”
Redington ALM & investment strategy director Dan Mikulskis says pension funds should anticipate change, pointing to the two middle ground options as the most likely. He gave both options a 35% probability each, followed by 20% for a complete alignment with CPI and 10% for no change. Mikulskis says either of the two middle options would lead to around a 60-70 basis points change in RPI.
So if RPI looks set to fall to some extent, what could that mean for schemes and other index-linked gilt holders?

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