No blubbing over the future of RPI please.

“I love the way they are doing this – it is not a move from RPI to CPIH, but recalculating RPI as if it were CPIH – and unless the Bank of England says that is a material change, eliminates any possibility of claiming this as a default. Still wannabuy those ‘risk-free’ gilts, as per TPR’s proposed Code??” – Con Keating

The Treasury’s announcement that RPI would morph to CPIH while still calling itself RPI was announced simultaneously with the Government spending review, prompting participants to criticize it as a £60bn raid on pension schemes. It is infact a £60bn raid on pensioners who will get lower pension increases but it is not increasing the liabilities of pension funds which promise RPI linking for pension increases. These schemes will still pay RPI but at a reduced rate. LCP’s  Jonathan Camfield, wirting in The Actuary Magazine summed up the efforts of pension schemes to float their deficits with gloomy black balloons

The angry brigade

All this makes comments from the purveyors of index linked gilts wrapped in LDI packaging very cross. This is about as cross as an LDI salesman can get (with a media policy guiding him)
The change from RPI to CPIH wipes £100bn off the value of these bonds, according to Insight Investment, a major pension investor. Jos Vermeulen, of Insight Investment, told the FT the firm was “disappointed” with Wednesday’s decision.

“This decision has been made despite substantial concerns being raised during the 2020 consultation, from a broad range of market participants,” he said. “Another chapter in the RPI saga has drawn to a close, but with 10 years until the decision is implemented, we struggle to believe that this is the final chapter, and we will continue to advocate for an equitable solution.”

The broad range of market participants are presumably Insight’s customers who had been sold long-dated RPI gilts as risk free assets. Often they had been buying RPI but promising CPI, a lower returning index than CPIH, banking the difference between what they held and what they had to pay as an asset mitigating deficits elsewhere.

What the Chancellor has done is unwind this artificial asset by narrowing the gap between RPI and CPI. In these cases it is the scheme funding that will suffer, but only because the scheme had got away with CPI indexation in the first place.

More generous schemes, that offered RPI, will see their liabilities decrease in line with the value of their assets, the losers in this case will be pensioners whose pension increases will be less generous from 2030 (but still more generous than if they had CPI).

So why is the pension industry blubbing?

Undoubtedly there is some skin in the game for those at the top of the pensions tree. Those senior pension figures with RPI linked pension promises in payment or soon to be in payment will lose out personally, unless they can find a way to get scheme rules to pay out on “old RPI”. I doubt that even the most brilliant lawyers will be able to argue that the Treasury are in default – as Con Keating points out – they aren’t changing the playing field, they are changing the rules of the game and they make the rules.

The pension industry is blubbing because they trusted the Treasury to be on their side and defend them as they have poured money into Treasury coffers over the past twenty years in the frenzy to de-risk pension schemes. Much of this has been smoke and mirrors stuff playing off corporate accounting policies and trustee funding statements using financial economics rather than common sense.

This has led to artificial funding gains resulting from “gearing” (borrowing to you and me) by buying derivatives of these RPI linked gilts at great expense to the pension funds who have to foot huge bills from the packagers of this “financial engineering”.

But while all this was being sold as “risk free” – it wasn’t. The risk was always there that the Government could change the rules of the game and these tears are the tears of crocodiles.

Those at the top of the tree are a lot more concerned that their reputations are now on the line and that a lot of these risk-free strategies now look a lot less attractive than they did at the beginning of last week.

Jonathan Camfield explains to other actuaries that much of their strategic planning over the past decade has been for nothing will need to be reversed

  • Does it still make sense to hold index-linked gilts and swaps to hedge CPI pension increases?

  • Changes in assumptions will lead to changes in member option terms, such as transfer values, pension increase exchange terms and commutation factors for converting pension to cash at retirement.

  • RPI changes could trigger further reviews of the appropriate index to use for pension increases under some scheme rules.

  • The knock-on impact on bulk annuity pricing may make insurance contracts more or less attractive to some schemes.

  • Trustees will need to think about appropriate communications to members in due course.

In short, the strategies were based on tactical plays which will now need to be reversed leading to extra costs to the scheme and little net gain to anyone but the advisers and fund managers

A more balanced view

I prefer the views of the eminently balanced Daniela Silcock, speaking for the Pension Policy Institute

“Some people are losing out but the economy overall should benefit if this is done correctly,”  Silcock told Pensions Expert.

The supposed threat to employers (following the proposals in the DB funding code)

The PLSA, who are now funded as much by the fund management industry as their pension schemes told the FT

“We are disappointed the government has chosen to disregard the detrimental impact this move will have on both savers’ retirement incomes. The change will also raise the risk of insolvency for employers as they seek to address the shortfall in funding of their workplace pension schemes.”

Those employers who have been following the advice of their consultants to de-risk with a view to buy out or self-sufficiency, have handed trustees billions to plug deficits calculated on discount rates determined by those advisers. This has been with the approval of the Pensions Regulator which is now proposing an acceleration of these “end-game” strategies to ensure that schemes do not tip into the PPF.

But the cost of these strategies is just what is pushing many such employers into the PPF, as – strong as the pension schemes appear to be, the cash flow drained from employers is leaving them unable to pay the operational bills. The PLSA cannot support the wholesale de-risking of pensions on the one hand , but complain that the adjustment to RPI is damaging employers – on the other. The wholesale rush to “risk-free” assets (gilts) over the past 20 years is the problem – and the risk that some of those gilts were over-valued has always been there.

So where does this leave the Pensions Regulator?

I can hardly imagine the Treasury’s decision went down well in Napier House, Brighton – home of the Pensions Regulator.

The extra costs associated with the decision are going to fall on the schemes that have been following the path advised in the funding code, those schemes that have not locked down into gilts are not the ones that will have to write off their RPI/CPI reserves.

The market new this was coming, the price of RPI linkers actually went up as a result of the announcement (the market had feared that the change would have come in from 2025 rather than 2030). If the gilts market knew, why is this coming as a shock to schemes and why has the Pensions Regulator been proposing schemes buy more of these over-priced gilts – when the risks were clearly understood?

To me, this suggests a fundamental rethink in what pension scheme investment strategies should be about. If pension schemes were set up to pay pensions, they should be investing in the long-term assets that make this country tick – businesses like Astra Zeneca that can do virus-beating things because of the backing of UK pension funds purchasing their equity. Rishi Sunak wants to get the money from the private sector going into  his £100bn reflation of industry.  That money is going to go into illiquid investment, not into funding more Government borrowing.

All this investment is at odds with de-risking and at odds with the DB funding code. to get Britain back on its feet , after the COVID punch to its solar-plexus, we will need to move towards a more ambitious approach to pension scheme funding and that means abandoning the mantra of “de-risking” and getting our DB pension schemes investing again. The Treasury’s message regarding the new calculation of RPI says just that.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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4 Responses to No blubbing over the future of RPI please.

  1. ConKeating says:

    I would point out that we will never know the true cost of this shift as RPI as we know it will no longer be calculated. However, the estimates of £60-£100 billion seem plausible. It is also clear that much of this was already discounted by the linker market.

  2. henry tapper says:

    Do you think that schemes and even the members with RPI indexation deserve compensation Con?

  3. ConKeating says:

    No. Bear in mind the price index has never been set in stone. There have always been modifications to it – most obviously the basket of goods captured by it. This is another change of larger impact but no different in principle.
    Perhaps the correct way of viewing this is that earlier pensioners got more than they should have.

  4. Bob Compton says:

    Just a few comments. RPI is a Retail Price Index, and used by pension funds as an approximation for inflation experienced by members receiving pension installments to maintain purchasing power. The trustees of most schemes with RPI hardcoded in their scheme rules may have the power to provide for discretionary increases over and above the 2030 RPI calculation.

    The real losers are the holders of RPI linked gilts which are in payment beyond 2030, particularly if we have a period of prolonged high inflation, as was the case in the 70’s and as will be highly likely the consequence of massive worldwide quantative easing.

    It is not just pension schemes that hold linkers.

    However as most pension funds pension increases with RPI have a 5% limit if inflation post 2030 is greater than 5% those schemes will have lost out on a source of real return. It remains to be seen if there will be a class action brought by the holders of the affected gilts.

    You re-published a very educational article last week, setting out the fact that both the RPI and CPI style indices calculation methodology are flawed, and that the Royal Statistical Society is developing a more suitable inflation measure. What is needed by pensioners is a measure that identifies pensioner cost of living increases (and decreases).

    I do agree however Henry with your comments regarding TPR’s appetite to push “de-risking strategies” when not comprehending the true risks involved.

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