Redington urges RPI/CPIH alignment at 'latest proposed time'

Redington has called for the alignment of RPI and CPIH to occur at the "latest proposed time" (2030), in its response to the government consultation.

The firm also stated that it supported the solution of redefining RPI as CPIH plus a margin, where the margin would "reflect the fact that CPIH has historically been lower than RPI on average".

The inflation measure alignment could see a fall in the total value of the index-linked market by as much as £80-100bn, Redington has warned, with defined benefit pension schemes to be “among the most impacted”.

Within its response to the ongoing consultation, the firm also warned that the earlier the proposed changes are implemented, the higher the magnitude of the loss.

It explained that holders of the final ‘relevant’ gilt would experience reduced coupons and an “immediate loss in value of the bond” if the alignment takes place before the maturity date.

Meanwhile, holders of the first two ‘relevant’ index-linked gilts would not be affected, as the bonds expire before the 2025-2030 window.

In addition to this, Redington also highlighted that, as the percentage of CPI-linked liabilities in a typical pension scheme reduces over time, the impact of the reform would be smaller the later it occurs.

As such, to reduce the size of value transfer, the firm has again called for the latest proposed time of 2030.

The firm noted, however, that part of the loss experienced as a result of any alignment would have already been incurred on a mark-to-market basis, with much of the market already pricing in some likelihood of the RPI reform.

It also clarified that the impact on DB pension schemes would be dependent on the type of inflation linkage in the liabilities and the inflation hedge programme in place.

For example, while schemes with RPI linkage in their liabilities and who have fully hedged their inflation exposure will see falls in both assets and liabilities, leaving funding levels broadly unchanged, there are nuances to consider.

Redington explained: "This is because for most schemes, inflation caps and floors will apply to certain tranches of member benefits, meaning that inflation hedging program can only by approximate and dynamic.

"As a result, there will actually likely be some winners and some losers."

It also highlighted that schemes with a substantial, long dated CPI exposure in their liabilities who are using RPI-linked gilts to hedge inflation, such as the Pension Protection Fund, are likely to see falls in funding levels.

In an extreme scenario, the firm estimated that a fully funded scheme with this arrangement could see as much as a 9 per cent decrease in funding levels if the reform occurs in 2025.

However, again highlighting the need for a later introduction of the proposals, the firm noted that this would be limited to a 7 per cent decrease if the change occurred in 2030.

It added: "For these schemes, the resulting funding shortfalls may need to be met by running riskier investment strategies and/or requiring further cash injections from sponsoring employers at a time when many are struggling to manage the economic consequences of the Covid-19 pandemic."

Aside from index-linked gilts, Redington warned that the reform would negatively affect the value of other financial assets, including inflation swaps, long-income assets, public/private index-linked corporate debt and infrastructure assets.

The firm also warned that the alignment could see DB pension benefits “significantly reduced”, reiterating warnings from Insight Investment, who called on pension schemes to engage with members on the potential impact of the reforms earlier this year.

The proposals have faced broad industry criticism, with the Pensions Policy Institute recently warning that the change could also increase DB scheme deficits.

The consultation has also recently been extended in light of the Covid-19 pandemic, with a government response now expected in Autumn 2020.

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