How will this impact pension schemes?
The change in the basis of calculation of RPI will have a significant impact on the value of index-linked assets and on the amount and value of benefits where RPI is used for pension increases and revaluation.
The scale of the impact will depend on the proportion of scheme assets that are held in index-linked gilts and other RPI-linked assets and, whether scheme benefits are linked to RPI revaluation and increases.
Some schemes, such as a scheme which uses index-linked gilts to match RPI-linked liabilities, may see no change although others will see a varying negative effect on their funding positions. Those schemes which have CPI based liabilities will perhaps be the most affected because of the need to hedge these liabilities using RPI-based products given the lack of a CPI based market. They will see a reduction in the value of index-linked bond assets but no equivalent change in liabilities. The PPF estimates that the aggregate funding position of these schemes could deteriorate by £10bn to £20bn.
A significant proportion of DB scheme members will also see a reduction the value of pension received. Although this may be welcome news for employers because of the reduction in scheme liabilities, any reduction in benefits will certainly not be welcomed by members and communication of the effect will need to be very carefully managed.
Trustees and employers now need to understand and assess the effect on their schemes together with their advisers so that they can begin to address the impact accordingly. This will include consideration of investment strategy, RPI based assumptions and triggers used in funding and transfer values, actuarial factors and any impact on the employer covenant. Trustees will also need to consider how best to communicate the announcement to members. There is clearly a great deal for schemes to be thinking about over the coming weeks and months.
Although the Response is largely as expected and does bring certainty this does not detract from the significant impact that the change will have on many DB pension schemes. The Response does acknowledge the 'particular impact' on defined benefit (DB) pension scheme members confirming that it will continue to 'keep the occupational pensions system under review' but, for the time being at least, it is clear that there are no plans for mitigation and what, if any, further action will be taken to support pension schemes remains to be seen