The U.K. government is planning a consultation in January on the future of the retail price index, a metric that defined benefit plans use to calculate pension benefits.
Sajid Javid, the U.K.’s chancellor of the exchequer, as the country’s finance minister is known, said Wednesday that because no index change can occur without a change in U.K. law and because of the government’s current focus on delivering a Brexit plan, the government will not be in position to eliminate the index just yet. Mr. Javid was responding to a proposal from David Norgrove, the chairman of U.K. Statistics Authority.
Mr. Norgrove proposed in March that RPI’s methodology should be aligned with consumer price index, another measure of inflation, which asset owners could use to calculate benefits. Plans to end the RPI and align the index with the CPI came about because of flaws the U.K. Statistics Authority said exist in the RPI, such as that the RPI consistently was higher than the CPI as an inflation measure over the years. Because of how it is calculated, the RPI inflated the value of benefits when it was used, for example, in inflation-linked portfolios.
Reacting to plans to end the production of the RPI index, industry participants warned that pension funds might see their funding ratios worsen based on the combination of methodologies they apply.
“The chancellor’s announcement today will likely inspire some mixed feelings amongst pension scheme trustees and sponsors,” said Matt Davis, partner at Hymans Robertson, in an emailed comment. “On the one hand, schemes that provide RPI-linked benefits who haven’t put in place much hedging may see improvements in funding levels if it turns out that this announcement leads to a drop in RPI expectations. On the other hand, schemes that have hedged CPI-linked increases with RPI-linked assets, which is a common risk management approach, could see funding positions worsen, to the extent that this news hadn’t been fully priced into the market.”
Jos Vermeulen, head of solution design at Insight Investment, said in a separate emailed comment: “One critical point Insight will be raising in its response to the 2020 consultation is the issue of compensation for those with RPI-linked assets or income. A change in the calculation methodology could potentially reduce many pensioners’ future incomes.”
Mr. Vermeulen added: “Compensation could take various forms, but the ultimate aim would be to reflect a change in methodology without creating winners and losers. This consultation may be the industry’s last chance to ensure the government adequately compensates the holders of index-linked gilts and to ensure that pensioners’ future incomes are protected.”
Source: Pensions & Investments