Steven Cameron, Pensions Director at Aegon said: “A technical change to the way the inflation index is calculated, as announced alongside the Spending Review, is an unlikely candidate for grabbing people’s attention. But if you’re one of the millions who receive an inflation protected pension from a defined benefit scheme or annuity, it could impact negatively on your pension income for the rest of your life. In recent years, the Government and its statistical teams have been gradually moving away from calculating inflation using the Retail Prices Index (RPI) and have been publishing the Consumer Prices Index (CPI) and an alternative including Housing Costs referred to as CPIH which it believes is a more accurate way of assessing changes in the cost of living. For example, the triple lock increases to the state pension are the highest of earnings growth, 2.5% or price inflation as calculated using CPIH. Today’s announcement means from 2030, the RPI will be based on the approach currently employed within CPIH.
“Over the last 5 years, CPIH year on year increases have been on average 0.8% lower than RPI. If this continues, someone who is already receiving or was expecting to receive increases in their defined benefit pension in line with the RPI, which will in future mirror CPIH increases might receive 0.8% less of an increase in future years. With people living longer, a pension can last for 30 years and while 0.8% might not seem like much, over 30 years it can make a big difference. For example, someone whose initial pension is £10,000 would with a 3% compound increase each year be receiving £24,273 in 30 years time, but with 2.2% increases, that would be £19,209 or a fifth less.
“While the Government and its statisticians may correctly argue that CPIH is a more robust measure of actual increases in the cost of living, this is unlikely to appease those in defined benefit pensions who’ll see this as losing out on what they believed they were entitled to. And this won’t just affect those who are already retired. Anyone in a defined benefit pension considering taking advice on transferring to a defined contribution pension is likely to see the transfer value offered cut to reflect lower future increases had they stayed in the scheme.”
Ian Mills, Partner at Barnett Waddingham, said; “Pensioners will be the big losers, but most won’t feel it for many years. Starting from 2030 this will result in a slow, steady erosion of their incomes, compared to what they might have otherwise reasonably expected.
“Coronavirus has transported the phrase ‘exponential growth’ from maths classrooms to the nation’s living rooms. What the chancellor has done here is introduced ‘exponential decay’ into the UK pensions system. Over many years those with RPI-linked pensions will slowly, but surely, become poorer than before today’s announcement.
“This will undoubtedly worsen the funding positions of many well-run pension schemes, putting deficits back on the agenda for companies across the land at the worst possible moment.
“There is some warped logic in not making the change until 2030 because it would be detrimental to holders of short-term index-linked gilts, whilst simultaneously ignoring the much larger impact on holders of long-term index-linked gilts (which may be of the order of £100bn).
“The calls for compensation were loud, but ultimately ignored. One does wonder whether this change will lower the UK’s standing in international lending markets. Unfortunately, this could happen at exactly the time the nation needs their support more than ever as the government will need to borrow record amounts from them for years to come.
“Some pension schemes will benefit from this – particularly those that have not attempted to manage their inflation risks. One could argue that this change is punishing the prudent and rewarding the reckless.
“This is arguably the biggest and cleverest stealth tax of all time. Rishi Sunak has managed to trump even Gordon Brown’s 1997 raid on pension funds.
“These changes to the RPI were proposed over a year ago and the Treasury has dragged their heels. The consultation responses included a clear message that the uncertainty this created has made life difficult for investors.
“There is still some detail on the implementation of the changes that is lacking. Having taken so long to decide on the future of RPI, the government should now establish mechanisms to ensure that RPI and CPIH do not accidentally diverge again after 2030.”
Nigel Peaple, Director of Policy and Research, PLSA, said: “We are disappointed the Government has chosen to disregard the detrimental impact this move will have on both savers’ retirement incomes and on the assets of UK pension schemes. The change, which will reduce the value of pension schemes’ investments by an estimated £60bn, will also raise the risk of insolvency for employers as they seek to address the shortfall in funding of their workplace pension schemes.
“The PLSA has advocated for solutions which mitigate the enormous cost to schemes, employers and savers, either through one-off payments or by technical measures that better reflect the higher value under the current RPI measure. The Government says it will keep the occupational pensions sector under review. We will certainly continue to press our case against this deeply unfair decision.”
Matt Davis, Partner, Hymans Robertson, says; “If RPI is aligned with CPIH from 2030 this will be a major blow both for pension schemes and their members.
“Many pension scheme members will be expected to get lower pension increases due to this change. It is common for pension schemes to pay pension increases linked to RPI so lowering the future rate of growth in RPI lowers the pension increases pensioners will receive. The impact varies according to how long the pension is expected to be paid for, but we project many younger pensioners and future retirees will see a drop in retirement income over their lifetimes of over 10% from this change. Members of defined contribution pension schemes that have purchased RPI-linked annuities would be expected to see similar reductions in their future annual increases. However, it is a crumb of comfort for pension schemes and members that the Government has stated it will continue to keep this matter under review given the number of responses from pension schemes.
“Pension schemes that have followed regulatory and industry best practice by hedging the inflation risk inherit in providing pensions are major holders of index linked gilts and other RPI-linked assets. This change means RPI-linked assets are expected to increase at a lower rate than previously anticipated, which makes them less valuable than before. The schemes that will be worst affected are likely to be those with high levels of inflation hedging and a high proportion of CPI-linked pension increases. In some cases these schemes could see a 10% fall in funding level. The Government has stated it will not offer compensation to holders of index-linked gilts which will have a huge detrimental impact.
“We expected this to have a very significant effect on investors as a whole. We estimate that the impact on the totality of index-linked gilt holders will be a loss in the region of £100 billion based on past differences between RPI and CPIH. Given the vast sums of money involved we expect to see continued pressure on the Government to review its decision not to compensate those due to lose out.”
|
