Steve Webb looks at the potential impact of a new measure of inflation called CPIH.
Earlier this month the Office for National Statistics (ONS) issued an apparently innocent statement which could have a multi-billion pound impact on the taxpayer and for occupational pension schemes.
After many months of debate the ONS decided that its preferred measure of inflation would no longer be the Consumer Prices Index (CPI) but a variant on the CPI which includes the housing costs of owner-occupiers - CPIH.
In the twelve months to September 2016, CPI rose by 1.0% and CPIH by 1.2%, though the relationship between the two numbers will obviously vary over time.
This apparently innocuous change could have a huge long-term impact on the cost of providing pensions going forward - but only if the Government decides to follow the ONS and make CPIH its own preferred measure of inflation. And, for reasons which we will consider, is very much an open question.
The importance of indexation can be seen by the furore that surrounded the last government's decision to switch from RPI to CPI as its headline inflation measure.
By using the (generally lower) CPI rather than RPI, the previous Chancellor quickly saved billions of pounds a year from the cost of uprating social security benefits. By using CPI as the benchmark for public sector pensions in payment, the public sector saved the equivalent of a lump sum of over £100bn on the present value of future pension liabilities.
By telling private sector pension schemes to use CPI (where their scheme rules allowed them to do so) rather than RPI, DWP estimates that such schemes saved a cumulative £80bn or so.
Although switching from RPI to CPI was controversial at the time, subsequent events have confirmed that persisting with RPI would have been increasingly difficult to justify.
The RPI is sufficiently flawed as a measure of inflation that the series has now been declassified as an official statistic.But CPI itself is not without its issues, and one of them was the omission of the housing costs of owner-occupiers.
Given that these amount to around 10% of the total spending of households, a variant which included imputed rents for owner-occupiers has much to commend it, and the ONS is clearly now satisfied that CPIH does the job.
You would have hoped that this ONS announcement would swiftly have been followed by confirmation from Treasury and DWP that they would follow the lead of the independent statistical experts and switching to CPIH. But the Treasury's initial response was that it had ‘no plans' to do so.
It is not hard to think why this might be. Assuming that the public finances are in much worse shape than was thought at the time of the Budget, Philip Hammond is not going to be too receptive to a measure of inflation which could be higher than the one currently in use (though lower than the old RPI).
A higher inflation figure would cost money on the benefits bill (except where rates are being frozen), and would increase the cost of providing public sector pensions.
Requiring company pension schemes to use CPIH for statutory pension revaluation and indexation rather than CPI would probably add to DB deficits at a time when they are already at near-record levels.
There are, therefore, understandable political and economic reasons why the Treasury and the DWP may want to bide their time on this issue. But they cannot have it both ways.
If the switch to CPI was needed because RPI was no longer the best measure, then the same must follow for the adoption of CPIH. If legislation on revaluation and indexation is to achieve its intended purpose then the government must use the best available measure. Anything else would unfairly erode the real living standards of millions of retired people.
Steve Webb is director of policy at Royal London
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