No reform of RPI until 2030

As expected, the Treasury issued its response to the consultation on the reform of RPI as part of yesterday's Spending Review.  The response confirms that:

• in order to minimise the impact of the UK Statistics Authority’s proposal to reform RPI on the holders of index-linked gilts, the Chancellor will not consent to the implementation of a proposal to reform RPI (such that the Authority intends to make) before the maturity of the final specific index-linked gilt in 2030, but
• the Authority would be able to legally and practically implement its proposal to reform RPI in February 2030.

Therefore, whilst the methodology for calculating RPI will not be updated to bring the methods and data sources of CPIH into the RPI until February 2030, we anticipate that the Authority will press ahead with its proposed reform from that time, as the response confirms that it remains the Authority's policy to address the shortcomings in RPI in full "at the earliest practical time".

Somewhat contraversially, the Government has also confirmed that it does not intend to compensate holders of index linked-gilts when this reform takes place.

After considering the consultation responses and advice from its Technical Advisory Panel for Consumer Price Statistics (APCP-T), the Authority has concluded that its preferred statistical method for bringing the methods and data sources of CPIH into the RPI remains that as set out in the original consultation document. This means that after the implementation of CPIH methods and data sources into the RPI, the RPI and CPIH will continue to be calculated separately in the manner set out in the consultation document on an ongoing basis, and will be published as separate indices and growth rates in the Consumer Price Inflation, UK Statistical bulletin.

Immediate actions

In light of this announcement, Trustees of DB schemes should:

• Urgently revisit any inflation assumptions to be used as part of a valuation that is in progress
• Consider the need to suspend transfer value quotations in order to review the inflation assumptions
• Review their inflation hedging arrangements and consider the impact on their scheme's investment strategy
• Review the impact on any de-risking policies and triggers
• Consider whether to review commutation and other factors used in member benefit calculations, and
• Consider suspending any pension increase exchange options that are currently offered to members and any GMP equalisation / conversion exercises that are planned or underway whilst they revisit the inflation assumptions.

At the same time, sponsors of DB schemes should:

• Urgently consider the impact on their end of year Company accounting figures
• Engage with their scheme's trustees on appropriate inflation assumptions for any valuations in progress
• Consider whether scheme rules require or enable a switch to CPIH (or CPI) indexation earlier than 2030, and
• Review the impact on any de-risking exercises that are in the pipeline.

Trustees will also need to consider the nature and timing of their communications with members about these changes given the sensitivities around this and then media coverage.

Comment

The CPIH gives a lower measure of inflation than the RPI - with CPIH having been around 1% lower per year on average in the past decade. This means that RPI inflation can be expected to be materially lower from 2030 than it would otherwise have been. Whilst this is five years later than it might have been (had the Chancellor consented to changes being made from 2025) it means that from that time:

• pension schemes and other investors with RPI-linked gilts will see a reduction in their investment returns
• pension schemes with RPI-linked benefits will see a reduction in their liabilities, and
• pension scheme members with RPI-linked pension increases will see a corresponding erosion in the value of their benefits compared with the amount they would receive if the reform of RPI did not go ahead.

Whilst there are strong technical arguments for reforming RPI, it will mean that some DB pension schemes and members will lose out. The schemes that stand to be the biggest losers are those with predominatly CPI-linked liabilities which are hedged using RPI-linked assets as they will lose out (from 2030) on much of the investment premium that they would otherwise have stood to receive. The impact of this may already have been felt by such schemes to the extent that the RPI market has already factored in this anouncement.

The fact that the Government is refusing to compensate pension schemes and other investors who lose out is contraversial and may lead to legal challenges being brought.

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