Industry figures warn RPI reforms could prove 'major blow'

The government’s decision to reform the Retail Price Index (RPI) to align with the Consumer Price Index including owner occupiers’ housing costs (CPIH) could be “a major blow both for pension schemes and their members”, according to industry figures.

The reaction comes after the government’s response to a consultation on the matter confirmed that the reform would take place no earlier than February 2030.

Explaining his concerns, Hymans Robertson partner, Matt Davis, said: “Many pension scheme members will be expected to get lower pension increases due to this change. It is common for pension schemes to pay pension increases linked to RPI so lowering the future rate of growth in RPI lowers the pension increases pensioners will receive.

“The impact varies according to how long the pension is expected to be paid for, but we project many younger pensioners and future retirees will see a drop in retirement income over their lifetimes of over 10 per cent from this change.

“Members of defined contribution (DC) pension schemes that have purchased RPI-linked annuities would be expected to see similar reductions in their future annual increases.”

Quilter financial planner, David Gibb, commented: “Many defined benefit (DB) pension schemes pay an income that is linked to RPI. As pension schemes are, by definition, a long-term product, just a small tweak in the methodology for increasing payments can have a huge impact on the value of the pension. For now, this has been kicked down the road and that should help give people time to plan appropriately.

“For those wishing to transfer to a DC scheme, transfer values may fall in future as these are tied to the value of gilts. Annuities also have payments linked to RPI and future annuity prices may not be lower to reflect the lower level of expected future benefits.”

Concern also abounded regarding the government’s confirmation that it does not intend to offer compensation to the holders of index-linked gilts.

Isio partner, Mike Smedley, said: “The government has dodged the legal ramifications of reforming the inflation measure before 2030 and has served up the unpleasant-tasting medicine with no sweetener. Hundreds of institutions and pension schemes responded to the consultation but pleas for compensation have been firmly rejected.

“I had expected the government to dodge the thorny issue of compensation for gilt investors, but instead it has taken the opportunity to deliver its tough message with no ambiguity.”

On the matter of gilts, Davis added: “We estimate that the impact on the totality of index-linked gilt holders will be a loss in the region of £100bn based on past differences between RPI and CPIH. Given the vast sums of money involved we expect to see continued pressure on the government to review its decision not to compensate those due to lose out.”

Looking into how much individual schemes could stand to lose out because of this, Buck principal and senior consulting actuary, Mark Alexander, noted that “calculations from the Pension Policy Institute show that a typical scheme holding £100m of index-linked gilts could see asset values fall by around £13m as an effect of this change”.

As such, LCP partner, Jonathan Camfield, commented that “the schemes that will suffer the most are those that have invested heavily in index-linked government bonds and have their benefit increases linked to CPI”, while he also noted that “those that have taken out buy-ins may be in a pretty good position”.

Pensions and Lifetime Savings Association (PSLA) director of policy and research, Nigel Peaple, said: “The PLSA has advocated for solutions which mitigate the enormous cost to schemes, employers and savers, either through one-off payments or by technical measures that better reflect the higher value under the current RPI measure.

“The government says it will keep the occupational pensions sector under review. We will certainly continue to press our case against this deeply unfair decision.”

However, not every scheme is set to feel the brunt of the reforms, as Barnett Waddingham partner, Ian Mills, explained: “Some pension schemes will benefit from this – particularly those that have not attempted to manage their inflation risks. One could argue that this change is punishing the prudent and rewarding the reckless.”

Despite the concern about how the change might impact pension schemes and members, most industry figures at least agreed that some sort of reform had been necessary.

Mercer partner and chief actuary, Charles Cowling, said: “RPI is clearly a flawed measure of inflation and replacing it to ensure future pensions are calculated fairly is the right thing to do. Unfortunately, doing so will inevitably create both winners and losers, though arguably the impact will already have been priced into the market to some extent.

“For companies and trustees, it is now crucial that they seek to understand the impact on their schemes so they can explain and communicate this clearly to their members. On the investment side, there is an opportunity to review hedging programmes to make changes that might lessen the impact of the switch.”

Gibb commented: “There is no disagreement about the need to ditch RPI as a measure of inflation. It has a number of statistical shortcomings in how it is calculated, which means that it has at times overestimated or underestimated the true level of inflation.”

Society of Pension Professionals president, James Riley, agreed, stating that the reform “removes one of the many uncertainties hanging over pension schemes currently and, at one level, this certainty is helpful”, but added that the reform amounted to “another lottery” in terms of its impact on schemes and members.

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