RPI reform to leave linker owners short-changed from 2030

Responding to a March consultation on aligning the RPI with the consumer price index including housing costs, chancellor Rishi Sunak determined that the change should not take place “before the maturity of the final specific index-linked gilt in 2030”.

The CPI runs at a lower rate than the RPI, typically by around 1 percentage point a year. An initial suggestion by the consultation would have seen the two methodologies merged by 2025.

Starting from 2030 this will result in a slow, steady erosion of pensioners’ incomes, compared with what they might have otherwise reasonably expected

Ian Mills, Barnett Waddingham

Among those adversely affected by the move will be defined benefit schemes with a high proportion of assets held in index-linked gilts, with the effect varying in accordance with which index is used to uprate their liabilities.

Respondents to the consultation had noted that funding positions could deteriorate and deficits increase, in particular among schemes with CPI-linked liabilities that hedge with RPI-linked assets.

“These respondents noted that… [RPI] reform will see the total value of their assets fall, while the total value of their liabilities will remain unchanged,” the government’s response stated.

However, the government added that DB pension schemes with CPI-linked liabilities are in the minority, with the index being used for around a third of benefits in the UK.

No compensation for index-linked gilt holders

Nonetheless, leading investors were less than impressed with the effective haircut to be applied to their assets.

Jos Vermeulen, head of solution design at Insight Investment, told Pensions Expert: “We are disappointed with today’s announcement that the government intends to go forward [with the reform].

“This is expected to reduce the future change in the RPI from 2030 onwards by one per cent a year, effectively transferring around £100bn of value from index-linked gilt holders (largely pension funds) to the government.”

He added that, though there are statistical problems with maintaining the RPI as a legacy index, “we do not believe that a solution should result in large transfers of wealth”.

Others have pointed to the impact on the overall wealth of pensioners, even if, as Barnett Waddingham partner Ian Mills said, “most won’t feel it for years”.

“Starting from 2030 this will result in a slow, steady erosion of their incomes, compared with what they might have otherwise reasonably expected,” he said, adding that what the chancellor has done is introduced “exponential decay” into the UK pensions system.

Daniela Silcock, head of policy research at the Pensions Policy Institute, explained that the timing change was likely due to the government being “concerned that there would be more of a pressure on the Treasury to redeem gilts if they did it in 2025”.

The delayed introduction would also give schemes and pensioners time to adjust, and may mitigate any shocks to scheme funding positions, she continued. A 65-year-old retiring this year will now see a 4-5 per cent decline in the value of their lifetime income, compared with around 8-9 per cent if the change had hit earlier.

“Some people are losing out but the economy overall should benefit if this is done correctly,” Ms Silcock said.

Overdue reform?

Charles Cowling, partner and chief actuary at Mercer, told Pensions Expert that the RPI “is clearly a flawed measure of inflation” and reforming it “is the right thing to do”.

However, he cautioned that “doing so will inevitably create both winners and losers”.

Matthew Giles, pensions partner at Squire Patton Boggs, explained that the move may bring some pending court cases to a premature end, as the question of whether the RPI is hard-wired into scheme rules “has become a less material issue”.

Nonetheless, he raised the possibility that more mature schemes, which would have been the beneficiaries of compensation, may contest the decision.

“The Pensions Policy Institute estimates that the change could result in a £60bn hit to pension scheme investments. Given the scale of the losses, there is the strong potential of legal claims arguing the legality of the change and the lack of compensation,” he said.