Two new price indices to be published for the first time tomorrow, along with the decision that Retail Prices Index (RPI) numbers will no longer be designated as National Statistics, add to the uncertainty over how some defined benefit pensions will be increased in future, according to Towers Watson.
From tomorrow, the Office for National Statistics (ONS) will begin publishing CPIH and RPIJ. CPIH will be similar to the Consumer Price Index (CPI) but will include a measure of owner occupiers’ housing costs based on how much it would cost them to rent similar properties. RPIJ has the same coverage as the RPI but uses a different formula for aggregating some price changes, which produces a lower measure of inflation. The ONS also announced last Thursday that RPI inflation numbers will no longer be National Statistics.
The Government has previously said that it would consider whether to base some pension increases on CPIH inflation rather than on CPI inflation once CPIH became available. Last week, the ONS said that throughout the seven years to 2012 CPIH inflation was always lower than or the same as CPI inflation. It was on average been 0.2 per cent lower and this was also the gap at the end of 2012.
Other pension increases continue to be based on Retail Price Index (RPI) inflation. January’s surprise decision from the UK Statistics Authority to publish a parallel index – RPIJ – rather than change the formulae used in RPI means that many employers sponsoring these schemes will not now benefit from the smaller pension increases they had anticipated being able to pay. In some cases, however, it may not be completely clear from scheme rules that RPI must continue to be used. Data published by the ONS last week shows that RPIJ inflation was 0.6 per cent lower than RPI inflation in the final months of 2012.
CPI vs. CPIH
Annual increases to public sector pensions and to some private sector DB pensions are based on the Government’s estimate of how the general level of prices has increased. Historically, the Government used RPI inflation but it announced in 2010 that future pension increases would be based on the CPI instead. CPI is also used for the inflation element of the “triple lock” under which the Basic State Pension rises by the highest of earnings growth, price inflation and 2.5 per cent.
Initially, the only difference between CPIH and the CPI will be that CPIH includes a measure of owner-occupiers’ housing costs, based on the rent that owner occupiers would have to pay on similar properties, with correspondingly lower weights on other items.
The Government has previously indicated that it would consider whether to use CPIH instead of CPI for pension uprating. Pensions Minister Steve Webb has said:
• ‘…the Consumer Prices Advisory Committee is looking at how owner-occupiers’ housing costs can be included in CPI…I understand that it is due to report in early 2013. I have said consistently that we will look at what it comes up with. Each year…the Secretary of State must take a view on the general increase in prices, and will certainly have regard to the work of the committee in doing so.’ (Hansard, 23 February 2012, col.1042)
• ‘The Office for National Statistics is currently consulting on the methodology for reflecting owner occupiers' housing costs in a new additional measure of consumer price inflation. We will need to consider the range of issues, including the outcomes of this consultation, before coming to any conclusion about the most appropriate measure for the purposes of uprating state benefits and pensions and public sector pensions in the future.’ (Hansard, 18 June 2012, col.706w)
In future, the inclusion of owner occupiers’ housing costs may not be the only way in which CPIH differs from CPI. In the analysis it published on 12 March, the ONS reiterated that ‘CPIH is not constrained by EU legislation and so its methodology will be developed to meet UK users’ needs, which could see further differences beyond housing costs, from the CPI’.
John Ball, head of UK Pensions at Towers Watson, said: “If the Government thinks that CPIH will remain below CPI, it might be tempted to adopt CPIH in order to save money on public sector pensions and elsewhere. However, it’s by no means certain that CPIH will remain lower. If rents rise faster than other prices in future, CPIH inflation would be higher than CPI.
“Switching from CPI to CPIH for pension purposes would affect most private sector DB schemes to some extent. Although many still use RPI to increase pensions in payment, most use CPI to increase pensions between the time someone stops building up new benefits and when they retire.”
RPI vs. RPIJ
Many private sector DB schemes have rules that make an explicit reference to the RPI, especially for the increases awarded after pensions have come into payment. The RPI-based pension increases from these schemes were not affected by the switch to CPI announced in 2010.
In January this year, the UK Statistics Authority accepted a recommendation from the National Statistician that it should not change how RPI itself is calculated and should instead respond to concerns about one of the formulae used in RPI by publishing a separate index, RPIJ, alongside it. On Thursday 14 March, it announced that updates to the old measure of RPI will no longer be National Statistics.
In estimates published last week, the ONS suggested that RPIJ inflation was 0.6 per cent below RPI inflation at the end of 2012. The gap has generally been about 0.6-0.7 per cent since 2010. (It was smaller in earlier periods. However, this is arguably less relevant to expectations about what it will be in future because changes to the way that clothing prices were collected, implemented in 2010, make headline RPI inflation higher.)
John Ball said: “Companies began the year expecting that RPI would be changed in a way that would reduce future payouts from final salary pension schemes. They had a rude awakening in January when the National Statistician announced that this would not happen after all. FTSE100 companies’ pension deficits increased by about £20 billion that day.
“It will often be clear that scheme rules require pensions to continue to be increased with RPI, but trustees should get legal advice where it is not obvious how their rules interact with the recent proliferation of price indices. In some cases, the waters could potentially be muddied further now that RPI is no longer a National Statistic. Unlike with RPI, however, pension increases in line with RPIJ may not be enough to satisfy the legislation at times when CPI inflation is higher.”
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