Mercer estimates that, across all FTSE 350 companies, the immediate effect of the Office of National Statistics (ONS) announcement to retain the existing method for calculating the Retail Price Index (RPI) could wipe up to £20 billion off company balance sheets through increases pension deficits. This would wipe out any gains that pension schemes made in the equity markets since the beginning of the year and is equivalent to the estimated value of deficit contributions paid by companies over 2012.
Whilst the decision to retain the existing method for calculating the RPI is a relief for many individuals in receipt of pensions and for holders of assets where the payout is linked to RPI, it comes at a cost. Investment markets had been anticipating that a change in the calculation methodology would result in lower levels of increase in the RPI over the long term. These expectations had resulted in the market pricing in a reduction in implied long term RPI expectations of around 0.3%. When the anticipated change didn’t occur, says Mercer, the market's initial reaction to the announcement on January 10th can be seen by the significant rise in inflation swap rates by around 0.3% - 0.4%.
Also, the consultancy says that short to medium-dated swaps rose more than the longest dated swaps while nominal interest rates remained broadly unchanged. Long-dated real yields fell with the 35 year index-linked gilt real yield, for example, falling initially by around 0.25%
According to Ali Tayyebi, Senior Partner and Head of Defined Benefit Risk at Mercer, “Most people expected the ONS to announce a reduction in the RPI calculation and this would have materially improved the balance sheet deficits. The opposite has actually happened. Inaction has meant an increase in market implied inflation which has increased pension scheme liabilities by around £20 billion.”
Moreover, warned Mr Tayyebi, the effect does not fall uniformly across all companies. Those pension schemes with rules drafted to use the Consumer Price Index (CPI) to determine the statutory rate of pension indexation will not have experienced any increase in liabilities. In fact, the Government's move to CPI gave them an unexpected but very welcome windfall gain, albeit at the expense of their pension scheme members.
”Companies with rules that prevented them from moving to the CPI must feel like they sinned in a former life,” continued Mr Tayebbi. “Having established high-quality schemes for their employees, the vagaries of historic legal drafting and a technical change to the RPI calculation mean that the liabilities they carry on their balance sheets could be over 5% higher than they would have been otherwise.”
The effect on individual companies will also depend on the assets that they hold, says Mercer.
“Those organisations with significant matching RPI linked assets, will find that the value of those assets has also increased to help to mitigate the impact of the change in the value of liabilities “, said Adrian Hartshorn, a Partner in Mercer’s Financial Strategy Group. “There are also implications for risk management strategies. For example, those companies with triggers in place to buy matching assets based on inflation will need to revisit the triggers. Companies with CPI liabilities will need to think carefully as to whether RPI linked assets really provide the best match for their liabilities.”
Employers with RPI linked benefits will have been hoping that the ONS's consultation would at least have provided them with some relief, by removing the unintended effect of changes to the RPI calculation over recent years which had actually increased this measure - In particular the change in the clothing part of the inflation index.
“All they can do now is to clutch at the straw left by the National Statistician,” concluded Mr Tayyebi, “that the ONS will continue to review how it collects clothing data, and hope that by improving their methodology for collecting data at least some of the difference will be removed over time”.
|
