RPI reform will hit some schemes more than others

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Defined benefit schemes like that of the Bank of England will be heavily affected by the Treasury’s proposed changes to the retail price index, and compensation seems increasingly unlikely given the state of government finances.  

Maths and politics are seldom compatible 

 
In March this year, the government launched a consultation on bringing RPI in line with the consumer prices index including owner occupiers’ housing costs at some point between 2025 and 2030.  
 
The UK Statistics Authority had long called for the ‘flawed’ RPI to be abolished, but many things are still linked to the measure – from government bonds, to private sector pensions and union-agreed salary uplifts. Numerous stakeholders thus stand to lose from any changes that are made, not least the government itself, which has been accused of index arbitrage – decreeing CPI increases for government payments like public sector pensions, whilst leaving the higher RPI in place where its income is concerned, such as student loan repayments. 
 
Pension schemes are among those that are most likely to feel a negative impact from the switch. A Pensions Policy Institute paper published in the spring found the total value of DB scheme assets invested in index-linked bonds is no less than £470bn, as schemes have increasingly invested in so-called liability-driven strategies. In 2019, 29% of private sector DB scheme assets were invested in index-linked bonds.  A switch to CPIH would reduce the value of these holdings by about £80bn if made in 2025 and by about £60bn if pushed back until 2030, the paper states.
 
The schemes most affected are likely to be the very mature DB schemes and "all those others which have succumbed to the siren voices of the LDI fraternity and decided ‘derisking’ was the only sensible funding strategy”, says Ian Neale, director at policy specialists Aries Insight. 
 
He adds: “As to what schemes can do, well, I might naively say ‘stop buying index-linked gilts’." 

For schemes that are using liability hedging, the RPI change adds considerable uncertainty, according to director at Independent Trustee Services, Dinesh Visavadia.
 
"The trustees , and other investors, are in a difficult place to find meaningful solutions without knowing how the compensation for the losses will work in practice," says Visavadia.

"After the changes are known, there will be a lot of work for the trustees in reviewing their hedging profiles and instruments used to ensure it meets their objectives," he adds.
 

BoE Pension Fund has its eggs in one basket 

 
One scheme that is particularly exposed to an RPI change is the Bank of England Pension Fund, with about £3bn of its £4.9bn assets in UK index-linked gilts, and about £1.5bn in UK corporate index-linked bonds like Network Rail’s. 
 
Given the PPI’s assumption that schemes would lose £13m in every £100m invested in linkers if the change were to take place in 2030, the scheme’s holdings could potentially lose £390m in value, and more if the change happens sooner.  
 
Trustee chair Anne Glover, a venture capitalist and non-executive director in the BoE’s Court of Directors, only said about the Treasury’s RPI consultation that “the trustee directors will review the outcome and take any actions necessary”. 
 
The scheme is currently reviewing its investments, but it is not clear what role the index change plays in the review. 
 
The fund, like many, will not just see a fall in asset value but also in liabilities. Currently it applies uncapped CPI increases for deferred and pensioner CARE liabilities and uncapped RPI increases for final salary pensions and accruing CARE liabilities.  
 
Those currently benefiting from RPI increases would see a reduction in their revaluations and pension increases, but given that the scheme is non-contributory, this might be viewed as a small price to pay. 
 
But not all pensioners that will be affected by these changes are likely to be as well provisioned for as Bank of England employees. The total loss in lifetime pension across schemes will average between 4% and 9%, and the PPI found that women and younger members in RPI-linked schemes will see the greatest reductions. It proposed that RPI could be reformed to align it with CPIH plus a spread, to mitigate against reductions. 
 
The Pensions and Lifetime Savings Association has previously called for compensation for pension scheme investors but given the financial strains the UK is facing because of Covid-19, it is difficult to see that this will be granted. 
 
Neale says logic would suggest no compensation, but politics might win in the end. 
 
“Rational economists will probably still argue anything like full 'compensation' is unaffordable, but politics often trumps economics and indeed anything else,” he said. 
  
The consultation on reforming RPI closes on 21 August. 
 

How are schemes preparing for 2030? 

Ian Neale