By William Fitchew, Senior Consultant, XPS Pensions Group
RPI has been on the receiving end of some criticism in recent years. The Johnson Review in 2015 recommended that the government and regulators end the use of RPI as soon as practicable. Furthermore, the chair of the UKSA stated that RPI is a poor measure of inflation. CPI is also not without its critics, a key shortcoming being that it does not take account of OOH costs.
Lords Economic Affairs Committee Report
The Lords Economic Affairs Committee (EAC) published a report on ‘Measuring Inflation’ in January 2019 following an inquiry in 2018. The EAC suggested that the UKSA could be in breach of their statutory duties by publishing an index (i.e. RPI) which ‘it admits is flawed but refuses to fix’. The Committee was of the view that the UKSA should request that RPI be fixed and that the Chancellor should agree to this.
Response from UK Statistics Authority and Chancellor
On 4 September 2019, the UKSA announced that it had proposed to the (previous) Chancellor that the publication of RPI should stop at some point in the future. In the meantime, shortcomings in RPI should be addressed by bringing methods used in CPIH into RPI.
On the same day the current Chancellor, Sajid Javid, announced that he did not intend to legislate to remove the requirement for RPI to be published. He also noted the potential for the proposed change to have ‘significant and diverse effects’, concluding that it must be appropriate to assume that users would need significant time to prepare.
Consequently, he said that the government would consult publicly on what date between 2025 and 2030 the change should be made. The UKSA will, at the same time, consult on technical matters relating to how to implement the proposed change. The government and the UKSA will publish a response before the 2020 Spring Statement and the end of the financial year.
The Chancellor reconfirmed that the government views CPIH as ‘conceptually the best measure of inflation’ and that its objective is that CPIH will become its headline measure over time. He also confirmed that the government has ‘no current plans to stop issuing gilts linked to RPI’. The announcement is silent on the question of whether the government might start to issue CPI-linked gilts. It remains to be seen whether the proposals are challenged, or if the alignment will be an ‘overnight’ change or phased-in over a period of years.
Occupational scheme pension increases
Once the change has occurred, schemes that have RPI ‘hard-coded’ in their scheme rules can expect to pay out lower pension increases in future, and hence smaller pensions, than they would otherwise have done.
Similarly, schemes that revalue deferred members’ benefits in line with RPI can expect to pay out smaller pensions in the future than they would otherwise have done. Current deferred pensioners could therefore be subject to a ‘double whammy’ of lower revaluation in deferment and lower indexation in payment.
Inflation assumptions
Inflation assumptions are required into the long term for a number of actuarial purposes e.g. funding valuations, transfer value bases and company accounting figures. Long-term RPI assumptions are typically set using data from gilts or swaps markets. CPI assumptions are often set by subtracting a margin from RPI assumptions. Consequently, both RPI and CPI assumptions might need to be reviewed.
Funding and investment impacts
All other things being equal, RPI is now expected to be lower than it was before and consequently RPI-linked investments, such as index linked gilts (ILGs), are expected to pay out less than they would otherwise have done. If there are future falls in long-term market expected inflation, these could impact schemes’ funding positions and also their hedging strategies.
Trustees of schemes with inflation-linked liabilities might wish to discuss with their scheme actuary the potential impact of the proposed change to any assessment of those liabilities, in particular where liabilities are being settled. Similarly, trustees of schemes with inflation-linked assets and/or inflation hedging strategies in place might wish to engage with their investment adviser and scheme actuary.
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