Impact of RPI to CPIH switch on pensions

Policy Lead for Defined Benefit and LGPS Tiffany Tsang explains why pension schemes and savers must be protected from the impact of proposed reforms to inflation indices.

A large portion of the pensions industry gave a collective gasp on Budget Day 2020. Not at the new Chancellor’s new proposals, but at the omission of mitigating factors in the joint consultation from HM Treasury and the UK Statistics Authority on aligning the Retail Price Index (RPI) to the Consumer Price Index including Housing (CPIH). The shock and confusion was from the knowledge of the financial consequences to come from this index move, for both savers and schemes, with the greatest impact hitting women and younger scheme members.

In the weeks that followed, we spoke with private pension schemes in our membership, engaged with other trade bodies and held our own internal membership roundtable to gather as many views as possible.

CPIH is widely accepted to be the better measure of inflation than RPI. However this impending reform will affect any holders of assets which have a value or return affected by RPI. This includes a large number of Defined Benefit (DB) pension schemes that have shifted towards de-risking investment strategies, some of which use index-linked gilts to hedge against inflation risk.

Independent research from the Pensions Policy Institute (PPI) released in March 2020 show that schemes invested in index-linked gilts could see an aggregate fall in UK pension scheme assets of between £60bn (if the switch is made in 2030) and £80bn (if the switch is made in 2025).

A significant fall in the income received from RPI-linked gilts would lead to a reduction in scheme funding. This funding gap would require higher contributions from employers – something that will be difficult to achieve in the current financial fall-out from COVID-19, the wider effects of which will not be fully seen until the virus crisis begins to abate.

For those schemes that uprate member benefits using RPI, there could be an average lifetime fall of up to 9% from an individual’s overall DB pension, though women will have a larger lifetime reduction, as they live longer. The year on year drop for individuals will be significant: a 65 year old in 2020 with DB income under RPI uprating would see a 17% fall from £6,300pa to £5,200pa if the change occurred from 2025. The equivalent scenario for a woman would see an income drop of 19%.

We also know that the gender pension gap is already a big problem. By their 60s, the median women’s private pension wealth is £51,100, which is approximately one third of men’s private pension wealth, coming in at £156,500. Does Government really want to be adding to the disparity in pension wealth – especially to groups we know are already more vulnerable over a lifetime to pay gaps and work security? Emerging evidence tells us that these same groups, those more reliant on flexible or part-time work, are also most likely to be financially impacted by Covid-19.

There needn’t be any losers if the Government wishes to reform the index to put it on a more statistically robust footing.

One or two mitigating measures could resolve what otherwise appears to be a transfer of wealth from schemes and hard-working savers to the government. The more radical approach could be for the government to cover future lost income upfront. Another solution could be what some are referring to as “CPIH + a spread”, where the spread reflects the projected long-term average difference between RPI and CPIH. In practice, gilts and benefits would pay out at CPIH, plus this additional spread.

The financial consequences, let alone the impact on scheme rules, of the RPI to CPIH reform cannot be ignored.  Prudent pension schemes invested in RPI-linked gilts in good faith, and should not face funding shortfalls, as a result of these reforms. As the research clearly shows, the impact on pension income and scheme assets will be significant, adding to an already mounting series of pressures on schemes and their sponsoring employers.

The consultation has now been delayed due to the coronavirus but the PLSA will be submitting a response calling for schemes and savers to be protected from any changes.