Inflation switch could cost schemes £80 billion

Government plans to align the Retail Price Index (RPI) with the Consumer Price Index (CPIH) could see pension schemes up to £80 billion worse off, the Pensions and Lifetime Savings Association (PLSA) has warned.

The UK Statistics Authority and the Treasury unveiled plans to align the inflation measures under a joint consultation in March. Following the change, monthly growth rates for the RPI and the CPIH will be the same, while annual growth rates will converge after the first year.

However, the RPI rate is structurally higher than CPIH by an average of around 1% a year, based on recent experience, which would result in defined benefit schemes being significantly impacted by the transition.

The Pensions Policy Institute has estimated that a switch to CPIH without any mitigating steps would reduce the value of the £470 billion schemes have invested in index-linked bonds by £60 billion if made in 2030 and £80 billion if done in 2025.

The PLSA has suggested that the government and the UKSA could adjust index-linked Gilts from RPI to CPIH, plus a transparently-calculated adjustment reflecting the expected long-term average future income of RPI over the new inflation measure. This would make the switch more “fair and equitable”, it argued.

“The decision to develop a more robust measure for inflation is the right one but the proposed methodology risks billions of pounds in pension assets,” said Tiffany Tsang, senior policy lead: LGPS and DB, at the PLSA. “Pension schemes have made RPI-linked investments in good faith, and under the guidance of the regulators, to prudently fund pension benefits. They should not face short-falls as a result of the changes,” she continued.

The new method of calculating how much to increase pensions each year to take account of inflation could result in cuts to people’s pensions of up to 9% over a lifetime, she added, which would make it less likely they will have an adequate income in retirement.

“In its plans to reform the inflation measure, we strongly urge the government to mitigate the detrimental impact this change will have on holders of index-linked Gilts and find an equitable transition away from RPI,” said Tsang.