On 11 March 2020, the government and the UK Statistics Authority will launch a joint consultation on Retail Price Index (RPI) reform. The government appears to be on a pathway to amend the underlying calculation of the RPI to bring the measure into line with the Consumer Price Index, including owner occupiers’ housing costs (CPIH) between 2025 and 2030. This would reduce the expected future change in the RPI by around 1% per annum.


If the RPI is simply amended to match CPIH, it would result in a wealth transfer of £90bn to £120bn from holders of index-linked gilts – predominantly UK pension schemes and insurers – to the UK government. The Defined Benefit (DB) pension sector has in excess of 10 million beneficiaries, the vast majority of whom will be impacted by the proposed change. This impact would either fall on their members if benefits are linked to the RPI, or on the value of their scheme assets if their benefits are linked to the CPI but they have hedged using index-linked gilts.

We would encourage all stakeholders to submit a response to the consultation when it opens – and to make the case for aligning the RPI with the CPIH, plus an appropriate margin, to ensure there are no losers as a result of any change.

The impact on your pension scheme
How the proposed change to the RPI affects your pension scheme will depend on the type of assets the scheme holds and the nature of its liabilities (see table).

Pension schemes with CPI-linked liabilities who have taken prudent steps to hedge these liabilities using RPI-linked gilts
will see their funding status deteriorate. RPI-linked assets are used because CPI-linked assets are in short supply; the total value of CPI-linked assets available is less than £10bn compared to the total value of RPI-linked bonds in issuance of c.£700bn. This change would come after many UK pension schemes have allocated significant portions of their assets to RPI-linked gilts – probably the biggest single shift in pension asset allocation made over the last 10 years – and significant purchases having being made after official reviews and consultations have concluded that the RPI would not be amended.

The proportion of schemes that would benefit from the change is low, as most corporate UK schemes have hedged a significant portion of their inflation risk.

Other implications
Some other significant impacts of changing RPI include the following:

  •  Inflation swaps: Inflation swaps are used by many organisations to hedge inflation risk and can have maturities as long as 50 years. For a pension scheme hedging inflation risk, the scheme pays a fixed return in exchange for an inflation-linked return. Most inflation swaps are linked to the RPI, so an inflation hedge would suffer as the fixed return would remain unchanged, but the RPI-linked payments received in return would fall.
  • Property and infrastructure investments: The RPI continues to be embedded in property markets, particularly for long- lease commercial contracts. Infrastructure investments can also have revenue streams that change with reference to the RPI. 
  • Individuals: Pensions linked to the RPI will not rise by as much as previously expected, and transfer values would fall. Separately, many annuities have RPI-linked payments: if the RPI was reduced, current annuitants could arguably have overpaid for the benefits they will receive. On the positive side, a fall in the RPI could lead to more constructive implications for student loan repayments and rail fares, both of which are linked to the measure. However, these positive outcomes could be achieved by other means – such as linking these factors to inflation measures other than the RPI.

Things to consider
If the RPI is simply aligned with the CPIH then, all else being equal, we believe that this would reduce the pension benefits received by millions of people and may result in a transfer of wealth from index-linked gilt holders to the UK government of c.£100bn.

Implications of the proposed RPI change for pension schemes

  FULLY INFLATION HEDGED  NOT INFLATION HEDGED
RPI LIABILITIES
Pension payments that increase in line with RPI inflation
Both asset and liability values will fall so your scheme’s funding level remains broadly unchanged Liability values would fall so your scheme’s funding level would increase
CPI LIABILITIES
Pension payments that increase in line with CPI inflation
Asset values will fall so your scheme’s funding level would reduce Both asset and liability values would be unchanged so your scheme’s funding level remains broadly unchanged

Source: Insight Investment. For illustrative purposes only.

However, a fair and equitable outcome can be achieved for everyone if the RPI is aligned with the CPIH, plus an appropriate margin, to ensure that there are no resultant losers.

We are therefore urging pension scheme representatives and members to respond to the consultation and call for an outcome which avoids an unintentional wealth transfer; to encourage their peers to respond, and to ensure other stakeholders and representatives are aware of the implications of the proposals.

We would encourage all stakeholders to submit a response to the consultation when it opens

For more information, please see Insight’s website focused on RPI reform at www.rpireform.com – where you can also read our white paper ‘Proposed Changes to RPI: Nobody Needs to Lose Out’.

Jos Vermeulen
Head of Solution Design – Insight Investment

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