The government is set to start consulting on how the Retail Prices Index (RPI) is calculated in its Budget on 11 March. Keith Webster warns the industry may currently be sleepwalking into this change.
The government has decided that at some point between 2025 and 2030 RPI will be changed so that it is calculated in the same way as another index, known as CPIH, a measure of the Consumer Prices Index which includes owner occupiers' housing costs. On average, CPIH increases by around one percentage point less each year than RPI. This change will therefore see many pensioners receive lower pension increases and pension schemes will suffer a fall in returns and asset values on investments such as index-linked gilts and swaps. However, the industry is currently sleepwalking into this change.
Lots of experts consider RPI to be fundamentally flawed as an inflation measure and it may be that CPIH is a better index. However, the issue we are facing is not which is the best index. The issue is how the Government is proposing to deal with RPI's flaws.
Why is this change being made?
The UK Statistical Authority is responsible for producing official statistics and has a statutory obligation to produce the RPI every month. It has, though, repeatedly said that it considers RPI to be fundamentally flawed. Nonetheless, back in 2013, it announced it would freeze RPI - ie leave it alone, warts and all. The pensions industry has operated on this basis ever since.
However, following a report in 2019 by the House of Lords Economic Affairs Select Committee, the USKA changed its position. It wrote to the Chancellor and suggested that RPI should cease to be published.
What if RPI was abolished?
If the Chancellor had agreed to the proposal to abolish RPI, he would be required to adjust returns on all index-linked gilts in a way which is just and equitable. It seems unlikely that the Chancellor could have decided it was just and equitable to move to returns based on CPIH without any upward adjustment to protect gilt holders.
Abolishing RPI would also trigger provisions in most pension schemes which would require the scheme to find a replacement method for calculating pension increases. This would allow some schemes to protect pensioners from the impact of this change.
What did the Chancellor decide?
The Chancellor rejected the proposal to abolish RPI. Instead he decided that RPI would continue to be published but would be changed so that it is calculated just like CPIH. RPI would be CPIH in all but name, but the name matters.
The Chancellor's approach means that index-linked gilt holders will, unless they mount a legal challenge, see a value transfer from investors to the government estimated to be around £90bn. Holders of other RPI linked invests will see equivalent losses. At the same time a pensioner with an RPI linked pension or an annuity will see a drop in their lifetime income of 10-15%.
The impact on individual schemes and members will differ from scheme to scheme. Those with unhedged RPI liabilities may see a funding improvement whilst those with hedged CPI liabilities are likely to see a drop in funding. However, all RPI linked asset holders will see a fall in value of their investments and all individuals with RPI linked pensions and annuities will see a reduction to their future benefits. That does not seem just and equitable and is something the pensions industry should perhaps be doing more to stop.
What can the industry do?
The consultation to be launched on 11 March is due to be about when and how this change will happen. It appears the government is not intending to consult on whether to make the change. The question of whether this transfer of wealth to the state is the right thing to do is not on the table. If trustees and employers want the consultation to deal with that question they need to demand it soon, by writing to the Chancellor before 11 March, otherwise it may be too late to challenge the outcome. They also need to respond robustly to the consultation to object to the proposal.
Keith Webster is pensions partner at CMS
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