RPI change: Schemes stand to lose up to £80bn
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The government’s proposed change to the flawed retail price index will increase overall DB deficits, potentially requiring higher employer contributions, as index-linked gilts will lose between £60bn and £80bn in value, a new paper has found.
On 11 March, as the chancellor announced unprecedented support for the economy in light of coronavirus, the Treasury also published a consultation proposing to change the way RPI is calculated.
The change would bring it in line with the consumer price index including owner-occupiers' housing costs, which would become the sole official inflation measure. This is because the UK Statistics Authority has found RPI to be flawed in its methodology. CPIH is not new; it has been the ONS’s lead measure of inflation for three years.
Scheme deficits ‘likely’ to increase
For defined benefit schemes, a change in the inflation measure would impact both assets and liabilities, as RPI annual inflation has been on average one percentage point per year higher than CPIH. Many private sector schemes have RPI-linked increases, while the rise of liability-driven investment has meant that more private sector schemes have exposure to index-linked gilts, which are to date also based on RPI.
The change to RPI could happen between 2025 and 2030, and the government’s consultation is focusing, among others, on the precise timing, but also on whether the switch would materially impact holders of so-called ‘linkers’.
The Pensions Policy Institute seems to say that it would. According to the institute’s latest briefing paper, sponsored by the BT Pension Scheme – which last year lost a court case to change some increases from RPI to CPI – the total value of DB scheme assets currently invested in index-linked bonds is around £470bn. In 2019, 29% of private sector DB scheme assets were invested in index-linked bonds.
A switch to CPIH would reduce the value of their holdings by about £80bn if made in 2025 and by about £60bn if pushed back until 2030, and, the paper notes, “there will also be material impacts from investments in other RPI-linked assets".
Daniela Silcock, head of policy research at the PPI, said: “As CPIH inflates more slowly than RPI, schemes invested in gilts will experience a drop in overall scheme assets of around £17m per £100m invested if the reform is introduced in 2025, and around £13m per £100m if the reform is introduced in 2030.”
How would liabilities change?
Changing RPI means many DB schemes will see a reduction in liabilities, as 64% of schemes uprate pensioner benefits in line with increases in this index, although most of these apply a ‘cap’ and a ‘floor’ to the upratings. In contrast, deferred member benefits are revalued in line with CPI by most schemes.
A change in the index used to uprate pensions means members will receive less, and the PPI found that women and younger members in RPI-linked schemes will see the greatest reductions. The total loss in lifetime pension across both sexes will average between 4% and 9%, it found. A 65-year-old man with a life expectancy of 86 and an average annual pension of £6,300 could see this drop to £5,500 if the RPI change is made in 2030. A woman with a life expectancy of 88 and an average pension of £6,200 could see her pension shrink to £5,300 a year.
For individual schemes, the liability reduction depends on the scheme population and proportion of the membership that have RPI-linked benefits, but for members aged 65 in 2020, they could see a reduction in liabilities of around 4% if the RPI change is made in 2030, and of around 8% if the change happens in 2025, while in respect of deferred members aged 55 at the moment, schemes could see liabilities go down by 12% or 17% if the change occurs in 2030 or 2025 respectively.
Should there be some mitigation?
“Mitigating measures could ensure that schemes, members and other RPI users do not experience a significant reduction in asset values or benefits,” the PPI said, proposing that RPI could be reformed to align it with CPIH plus a spread, where the spread would be calculated to reflect the expected long-term average difference between RPI and CPIH. Gilts and benefits could continue to pay out at the index, plus the spread.
The Pensions and Lifetime Savings Association’s policy lead for DB and LGPS, Tiffany Tsang, called the index change that would reflect price inflation more accurately a “stealth tax on retirees”, calling for measures to soften its impact.
“Workers’ savings must not be unduly compromised by an administrative change in the measure of inflation that acts, in effect, as a stealth tax on retirees. Any change should therefore necessarily be offset by fair and appropriate mitigation for schemes,” she said.
Tsang added that the impact on DB schemes must be considered: “RPI is a flawed measure of inflation, but plans to phase it out must take into consideration the £60-80 billion impact on pension schemes, which have made RPI-linked investments in the interests of their members, in good faith."
