Potential changes to the way the Retail Prices Index (RPI) is calculated and reported could cause assets to fall by between £60bn and £130bn, according to various estimates.
The Treasury is consulting on aligning RPI with the housing-cost-based version of the Consumer Prices Index (CPIH) somewhere between 2025 and 2030 following years of criticism of how the inflation measure is calculated. The consultation closes today (21 August).
CPIH tends to be around one percentage point lower than RPI and, with schemes invested heavily in index-linked bond, any downgrade is likely to cause a material impact on asset values.
Pensions Policy Institute research said a switch to CPIH could reduce scheme investments by £60bn if implemented in 2030, or £80bn if in 2025. Meanwhile, the Association of British Insurers (ABI) estimated a total cost to schemes and investors of £122bn in 2025, or £96bn in 2030, and Insight Investment predicted a drop in asset values for schemes and investors of up to £130bn.
The Pensions and Lifetime Savings Association (PLSA) urged any change to the index to be via a "fair and equitable" transition, such as by adjusting index-linked gilts from RPI to CPIH while adding a "transparently calculated adjustment reflecting the long-term average future income of RPI over the new inflation measure". Alternatively, the government could pay any future lost income upfront.
The association said the transition for benchmarks from Libor to Sonia had established a precedent, with a working group established a minimal impact on stakeholders - and the RPI reform should happen as close to 2030 as possible to enable a similar approach.
Senior policy lead for Local Government Pension Scheme (LGPS) and defined benefit (DB) Tiffany Tsang said: "The decision to develop a more robust measure for inflation is the right one, but the proposed methodology risks billions of pounds in pension assets. Pension schemes have made RPI-linked investments in good faith, and under the guidance of the regulators, to prudently fund pension benefits. They should not face shortfalls as a result of the changes."
The PLSA also estimated that individual pension scheme members could lose an average of between 4% and 9% of their total lifetime income, while a man aged 65 this year could see a 17% drop if the changes were implemented in 2025. For a woman, the corresponding figure would be 19%.
"Moreover, the new method of calculating how much to increase pensions each year to take account of inflation could result in cuts to people's pensions of up to 9% over a lifetime. This will make it less likely they will have an adequate income in retirement.
"In its plans to reform the inflation measure, we strongly urge the government to mitigate the detrimental impact this change will have on holders of index-linked gilts and find an equitable transition away from RPI."
Insight Investment made a similar prediction, warning up to 20% of expected income could be lost for DB scheme members. It called on the government to "give careful consideration" to any changes, bearing in mind that, due to market movements as a result of Covid-19, the impact could be £10bn higher now than it would have been if it had been in March.
Head of solution design Jos Vermeulen said: "The impact of reform will be felt immediately by pension schemes and individuals - this is not a problem for 2025 or 2030, but for now. For pension schemes, the resulting hit to their funding levels may only be compounding problems for companies which are already struggling with deficits in light of the Covid-19 crisis, making it even harder to plug these gaps.
"For individuals, the impact on their savings will also be immediate. Our calculations have shown that the current proposal could see members losing up to 20% of their expected income. This will have a significant effect, not only for those entering retirement but also any members who may be looking to enter pension transfer deals and suddenly find their hard-earned pots are worth significantly less."
The ABI called for the latest possible implementation date in order to reduce the impact on savers, and also recommended compensation for savers was given.
Outgoing director of conduct and regulation Hugh Savill said: It is widely accepted that the RPI model is less than perfect, but the proposal's impact will be felt by policyholders and pension savers for decades.
"If the reforms go ahead, and given the impact for savers and the wider economy, it is vital the implementation date is later rather than sooner. Compensation by the government should also be seriously considered to avoid creating winners and losers."
Commenting on the ABI's figures, AJ Bell senior analyst Tom Selby said a quick switch could represent a "stealth cut to people's hard-earned retirement pots".
He continued: "The big question the government needs to answer is the extent to which it will mitigate any negative impact on people with pensions and investments explicitly linked to RPI. One option in this regard would be to maintain a national RPI which these contracts could then adopt, although this might mean RPI remains part of the system for decades."
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