The chair of Airways Pension Scheme Trustee Ltd, Roger Maynard, has warned that possible reforms of the retail price index could cause great injustices, as well as undermining trust in the issuance of index-linked gilts.
In their response to the government’s RPI consultation, which closes on August 21, the two British Airways pension schemes are the latest in a long line of defined benefit pension schemes to signal their opposition to replacing the flawed index with a version of the consumer price index incorporating housing costs.
RPI has typically run around 1 percentage point higher than CPI and its variants over the years. While restating RPI liabilities as CPI could be beneficial for DB schemes, the corresponding drop in the value of RPI hedging assets means that some could be exposed to funding level drops.
For a 65-year-old pensioner, their pension would be about 30 per cent less if they were lucky enough to reach the ripe old age of 100
Hemal Popat, Mercer
Trustees of both the 21,000-member APS and the 63,0000-member New Airways Pension Scheme believe that abolishing the RPI in favour of the CPIH measure of inflation could lead to worsening funding, weakening APS and increasing the deficit in NAPS, which had a £2.4bn shortfall at the last valuation.*
If the reforms were to proceed, British Airways Pensions would strongly support a refinement to redefine RPI as CPIH with a margin — with a subsequent consultation on setting the margin.
Captain Mike Post, past chairman of the Association of British Airways Pensioners and former trustee of both schemes, said: “The proposed change to the methodology of calculating the RPI has been compared with contracting to supply Toblerone for 100 years and then half way through the contract omitting the honey from the ingredients.”
Up to 10m pensioners stand to lose out
The problem is particularly acute for pensioners, with up to 10m standing to lose out if RPI was abolished. Actuaries differ in their estimates of the exact loss for those with RPI-linked pensions.
Hemal Popat, director at Mercer, said: “For a 65-year-old pensioner, their pension would be about 30 per cent less if they were lucky enough to reach the ripe old age of 100.”
Ian Mills, partner at Barnett Waddingham, commented: “A member currently aged 65, with an RPI-linked pension paying £10,000 a year, would have previously expected to receive about £380,000 in total if they lived to age 90. If the changes go through from 2025, then the member’s total payments would be reduced to around £350,000 by age 90.”
Every UK DB pension scheme affected
The changes will affect nearly every single DB pension scheme in the UK. For example, BT has said the inflation change could cost its pension scheme up to £1.7bn.
Matt Davis, partner at Hymans Robertson, said: “Holders of UK index-linked gilts are at risk of a collective loss of around £100bn from RPI reform. Consequently, it is vital to consider the real-world implications of proposed RPI reform rather than placing too much focus on the more abstract question of statistical rigour.”
Meanwhile, experts have said that the government appears to have shown little thought for how to compensate investors in assets linked to varying inflation standards.
Mr Popat said: “Schemes with high levels of inflation hedging will typically see falling funding levels, with the fall being larger the more CPI-linked liabilities there are. Conversely, many schemes with low levels of inflation hedging will see rising funding levels, with the rise being larger the more RPI-linked liabilities there are.
“One exception to this is public sector schemes that have CPI-linked liabilities and will therefore suffer losses on their index-linked gilt holdings.”
Lynda Whitney, a partner at Aon, noted that the publication of correspondence between the Treasury, the Office for National Statistics, and the UK Statistics Authority in September 2019 had led to a fall of around 20 basis points in longer-dated gilt assets.
“We still do not think that a shift to CPIH is fully priced in and a move to RPI without compensation would cause a further fall in the value of index-linked gilts, and so continue to weaken the funding position of these schemes,” she said.
Mike Smedley, partner at Isio, said: “The schemes with most to lose are those that changed to CPI back in 2010, where the only real option for hedging has been index-linked gilts.
“For these schemes, pensioners have already taken the pain, and without compensation for index-linked gilt holders the scheme could face further losses on their hedging assets. Trustees and sponsors of these schemes will feel harshly treated if they are punished for following the strong regulatory steer to hedge their risks.”
All schemes will need to review their position. Some may benefit, and Mr Mills noted: “They’re much closer to being able to buy out than they thought possible... while schemes that are adversely affected may need to draw up plans to readdress deficits that they thought they’d already dealt with.”
Inconsistencies abound, as Jane Kola, partner at Arc Pensions Law, pointed out: “The government should stop the index arbitrage in government affairs by using RPI on things like student debt and rail fares but CPI on pensions and benefit payments.”
For DB schemes, their biggest challenge “is the uncertainty caused by the slow and lingering death of RPI”, Mr Smedley added.
“It may be 2030 before RPI is on the scrapheap. Even the best-run schemes can’t face two directions at once. No one wants another 10 years of doubt, and the best outcome would be certainty for all stakeholders.”
*This article has been updated to clarify an inaccuracy in the reporting of British Airway's deficit.
