In depth

UKSA's RPI reform will go ahead from 2030 with no compensation for index-linked gilt holders

Gateley Legal

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The Government and the UK Statistics Authority (UKSA) response (the Response) to their joint consultation on addressing the shortcomings of the Retail Prices Index (RPI) was published alongside the Chancellor's Spending Review on 25 November 2020. 

In summary, UKSA's planned reform of RPI which will involve aligning it with the Consumer Prices Index including owner occupiers' housing costs (CPIH) will go ahead, but not until February 2030; the Chancellor did not consent to any earlier implementation date because of the effect of the reform on index-linked gilt holders. Despite numerous calls for the impact of the change to be mitigated, there will be no compensation from the Government to index-linked gilt holders to mitigate for any detrimental consequences. 

Although CPIH is commonly considered to be a more suitable measure of inflation RPI it is typically higher than CPIH and, as a result, many pension schemes will be adversely impacted by the change. Pension benefits that revalue or increase by reference to RPI are anticipated to reduce from 2030 and it is also expected that the change in RPI will reduce the value of RPI-linked investments held by many pension schemes, for example, index-linked gilts or Liability Driven Investments. Trustees and employers will need to consider carefully the impact of the Response together with their advisers before taking steps to address the change.
 

Background to the consultation

UKSA announced back in September 2019 that it intended to address the shortcomings of RPI by bringing the methods and data sources of CPIH into RPI. 

However, because of RPI's use in two specific index-linked gilts, the consent of the Chancellor is required should implementation take place before 2030 and the Chancellor announced that he would consult publicly on whether the change should be made at a date other than 2030, and if so when between 2025 and 2030. The joint consultation was then launched at the Budget on 11 March 2020. 
 

Timing of the Change

The Response confirms that the RPI change cannot take place until February 2030, the date that the final specific index-linked gilt matures. The Chancellor announced that, although he could see the statistical arguments in support of UKSA's proposed reforms, he was unable to give his consent to the change taking place before 2030 because of the need to lessen the impact of the change on the holders of index-linked gilts. 

UKSA's intention is to implement the change in RPI at the 'earliest practical time' which means that the change is expected to take place in February 2030 although a definitive date has not been specified. 

Confirmation of how RPI will change

The Response confirms that the approach outlined in the consultation document for bringing the methods and data sources of CPIH into RPI remains UKSA's preferred statistical method. In practice, this involves calculating RPI index values using the same methods and data sources that are used for CPIH, with monthly and annual growth rates being calculated directly from the new index values. RPI and CPIH will still be calculated and published separately.

Calls for mitigation of the impact

Responses to the consultation including those from the Pension Protection Fund (the PPF), the Pensions and Lifetime Savings Association and the Association of British Insurers (the ABI) emphasised the impact that the change would have on index-linked gilt holders such as pension schemes and their members and called for the Government to take steps to mitigate the negative consequences of the switch. 

Pensions Policy Institute (PPI) research estimated that a switch to CPIH could reduce scheme investments by £60bn if implemented in 2030 and the ABI found that implementing the reform in 2030 could cost £96bn. 

However, the calls for further mitigation have not been heeded by the Government; the Response confirms that the Government "will not offer compensation to the holders of index-linked gilts" given that UKSA's proposal will result in no change to the contractual terms of index-linked gilts which reference the use of RPI as the index ratio.
 

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

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