Switching inflation indices: How aligning RPI with CPIH will affect schemes

The Retail Prices Index (RPI) has suffered a barrage of criticism for a number of years, with many contesting whether the index is an appropriate measure by which to measure inflation.

Indeed, after the government moved the uprating of benefits for public sector schemes away from RPI to the Consumer Prices Index (CPI) in 2011, many other funds in the private sector have attempted to follow suit - some more successfully than others.

Now, this disapproval and, for some, misery is due to come to an end as HM Treasury has confirmed plans to gradually align the index with a housing-cost based version of CPI, known as CPIH.

 

Gradual change

Announced on 4 September by Chancellor of the Exchequer Sajid Javid, the move will be made over the course of the decade to 2030 in an aim to minimise disruption and provide ample time for RPI users to prepare.

It comes after the House of Lords Economic Affairs Committee told the government to switch from RPI to CPI, noting the former index was now "untenable" due to a long-standing error in its calculation.

In a letter to national statistician and UK Statistics Authority chairman Sir David Norgrove, Javid said any decision needed to consider "the integrity of the system, the effect on the public finances and on the holders of specific index-linked gilts".

He added: "Addressing the flaws in this way may be a more efficient approach than continuing to ask users to stop using it and rewriting existing contracts, but it does not remove many of the implications."

The government had already, in its Budget last October, announced its intention to move public sector pension schemes and index-linked gilts over to CPIH "when and where practicable". Now, in this letter, Javid also said "the government will not introduce new uses of RPI", but "will continue to consider" how the index is used.

Digging schemes out of a hole

It is almost an override for schemes that peg the uprating of benefits to RPI, and helps overcome the challenges of changing the index. However, unlike a statutory override many in the industry have called for, it will also affect index-linked assets.

Pinsent Masons partner Alastair Meeks said schemes had been "the poor bloody infantry" as statisticians underwent "an extended nervous breakdown" on how to measure inflation.

"Many have been stuck with RPI as a measure of inflation that no-one regards as satisfactory, and that has been downgraded from its former status as a national statistic but which is still produced and which their rules require them to use.

"Today's announcement would dig those pension schemes out of the hole that the government had dug them into."

Assuming there is no change in government in the near future, the consultation on the proposed changes will open in January 2020, asking whether the change should be made before 2030 and, if so, when between 2025 and 2030. A response is then expected to be published before the Spring Statement and end of the financial year.

Problems

But the move will not come without problems. At the very least, asset values may reduce as the yields of gilts fall.

Hymans Robertson partner Matt Davis explains: "The chancellor's announcement will likely inspire some mixed feelings among pension scheme trustees and sponsors.

"On the one hand, schemes that provide RPI-linked benefits who haven't put in place much hedging may see improvements in funding levels, if it turns out that this announcement leads to a drop in RPI expectations.

"On the other hand, schemes that have hedged CPI-linked increases with RPI-linked assets… could see funding positions worsen, to the extent that this news hadn't been fully priced into the market."

This move has already begun, with LCP partner Alex Waite noting there was an immediate 5% fall in the price of longer-term gilts, adding: "For many pension schemes, we expect immediate impacts on the funding, accounting, and buyout position, and some of these could be material."

Furthermore, Meeks believes the timetable could prove difficult for schemes, noting there are "two worms in the apple".

"First, the government is hardly rushing: 2025-30 for implementation of the change is not breakneck speed," he notes.

"Secondly, when will pension schemes be able to reflect this in their valuations and funding plans? The difference in cost between the two measures is substantial but, until any change is made, employers will need to be paying (and perhaps overpaying) contributions into their pension schemes on the existing basis."

While the move will be welcomed by many schemes hoping to change index, it does not help those immediately seeking a switch, who will still need to rely on the exact wording of their rules to uncover whether this would be legally permissible.

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• Topics
• Investment
• Defined Benefit
• RPI
• Retail Prices Index
• Consumer Prices Index
• CPIH
• Pinsent Masons