Investment consultants and the Pensions and Lifetime Savings Association welcomed clarity over the future use of the retail price index to calculate U.K pension benefits and liabilities, but warned that the change will still be detrimental to participants.
Chancellor of the Exchequer Rishi Sunak announced Wednesday that the RPI calculation of inflation will be reformed to bring it into line with another measure of inflation — the consumer price index — starting in 2030 at the earliest. The change was proposed earlier this year in a consultation by HM Treasury and the U.K. Statistics Authority.
Plans to reform the RPI and align the index with the CPI came about because of flaws the U.K. Statistics Authority said exist in the RPI. These flaws include that the RPI consistently was higher than the CPI as an inflation measure over the years. Due to the difference in calculations, using RPI inflated the value of benefits when it was used, for example, in inflation-linked portfolios.
However, despite the clarity over the timeline for introducing the change, market participants are still concerned over the impact of the change on pension funds. Consultants estimate that index-linked gilt investors could see losses of about £100 billion ($131.9 billion) based on past differences between the two indexes. The U.K. Pensions and Lifetime Savings Association estimates the impact could be about £60 billion.
Industry sources also said a move to RPI could increase the risk of insolvency for employers seeking to plug any deficits, because RPI-linked assets in pension fund portfolios are expected to grow at a lower rate than previously anticipated.
"If RPI is aligned with CPI from 2030, this will be a major blow both for pension schemes and their members," Matt Davis, partner at Hymans Robertson, said in an emailed comment. "The schemes that will be worst affected are likely to be those with high levels of inflation hedging and a high proportion of CPI-linked pension increases.
"In some cases these schemes could see a 10% fall in funding level," Mr. Davis added.
The change is expected to affect plan participants, who will see a drop in retirement income over their lifetimes of over 10% as a result of this change. Defined contribution plan participants who have purchased RPI-linked annuities could see similar reductions in the value of their retirement savings.
"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," Mr. Davis said.
Commenting on the decision, Jonathan Camfield, partner at consultant Lane Clark & Peacock, said, "Schemes may see falls in their assets, but on the liability side the situation is more nuanced and the liability value could either decrease or increase. This is because they typically depend crucially on both RPI, which is essentially decreasing on this announcement, and CPI, which might be assessed differently in the new market environment."
But consultants agreed that RPI is a flawed measure of inflation. Charles Cowling, partner and chief actuary at Mercer, said in a separate comment: "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."