The gap between the two most frequently used measures of inflation, RPI and CPI, has grown in recent years. Rebasing of public and some private sector pensions to CPI has been criticised in some sectors, at worst sparking national strikes over pension reform.
At the heart of the issue is the differential or “wedge” between the CPI and RPI, which has meant that for a 2% CPI target in steady state, RPI might typically be higher by about 1% per annum with this differential itself being volatile.
The Consumer Prices Advisory Committee (CPAC) is currently considering changing how inflation is measured. In order to help trustees and others involved with pension schemes understand the implications and take appropriate measures, Redington and Pension Insurance Corporation today publish an explanatory note on the possible impacts of the inflation indexation reform currently being considered.
Moves to narrow the RPI/CPI wedge would hit:
• Issuers of index-linked bonds – both Government and private sector
• Buyers of these bonds who may start pricing in a “political risk” of further future changes to calculation methodologies.
• Buyers of these bonds who may start pricing in a “political risk” of further future changes to calculation methodologies.
• RPI swaps participants
• Pension schemes offering inflation-proofed pensions
• Pensioners with inflation-proofed pensions
Possible changes, like the previous move to change statutory indexation from RPI to CPI, highlights the need for pension scheme trustees to fully understand the financial implications of inflation on their liabilities.
Dan Mikulskis, director of ALM and investment strategy at Redington, said:
“Overall, lower inflation and expectations of future inflation will, other things being equal, lead to a decrease in scheme liabilities, which will help pension schemes labouring under the effects of ultra-low gilt yields caused by Quantitative Easing and safe haven investing. However, trustees need to understand what moves will do to their specific pension scheme.”
Jay Shah, co-head of business origination at Pension Insurance Corporation, said: “Whilst this topic is somewhat technical, inflation is important for pension scheme liabilities. It is therefore critical that trustees fully understand what the potential moves to reduce or remove the difference between the RPI and CPI mean and how they might impact their liabilities. Ideally trustees should also be hedging out their inflation exposure as do insurers.”
The National Statistician has published a consultation document to seek users’ views on a range of options for the way the RPI is calculated. Any changes are expected to be introduced with the annual update of the RPI when it is published on 19 March 2013.
The report is available for download at: www.redington.co.uk and www.pensioncorporation.com
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