On 11th March this year, the government launched a consultation on the Reform to Retail Prices Index (RPI) Methodology.
If implemented, the proposals in the consultation are damaging for APS, NAPS and the wider UK pension industry
There have been a number of consultations on RPI to date, mostly concerned with whether it’s an appropriate index of inflation. The UK Statistics Authority (UKSA) no longer classifies it as a “national statistic”, emphasising the consumer price index (CPI) instead. RPI remains in use by the government as a base for various purposes, such as the amounts payable on index-linked securities including index linked gilts (ILG) and for various index-related rises of fares, taxes and social housing rents. It’s also commonly used by employers and unions as the basis for wage rises.
In March 2019, the UKSA made a recommendation to the Chancellor of the Exchequer to address all of the shortcomings of the RPI. The core of this recommendation is a proposal to align RPI with the Consumer Prices Index incorporating housing costs (CPIH – in the long term, CPI and CPIH rises are roughly the same). At present the UKSA requires the consent of the Chancellor to make this change but this requirement for consent expires in 2030.
Neither the UKSA nor the government have the full knowledge of the use of the RPI in the economy and financial contracts. Any change to RPI could have wide unintended adverse impacts, CPIH annual rises being on average one percentage point less than RPI annual rises. Therefore the Chancellor has chosen to hold this consultation on when this change should take place, between 2025 and 2030. The consultation closes at 11:59pm on 21 August 2020. Disappointingly, there are no other options suggested in the consultation. The consultation can be found here:
BA Pensions Response
The APS Trustee and the NAPS Trustee have each prepared specific responses to the consultation. These were submitted on 2nd July and the respective Trustees have shared redacted versions (minus sensitive financial information) with ABAP, for which we greatly thank the Trustees. These are now published on the BA Pensions website in the “Latest News” section from where they can be downloaded:
What does it mean for APS & NAPS?
Both APS & NAPS will be adversely impacted by the proposal to align RPI & CPIH.
APS members will be aware of the long running campaign and legal action to regain RPI rises, resulting in a settlement (approved by the High Court in November 2019) providing a framework for returning to RPI equivalent rises by 2021. If RPI is to be aligned with CPIH at some future date, the benefit of this settlement will be short-lived.
The various buy-ins and recent reinsurance of APS pensions in payment have been made on the assumption of RPI level returns. If RPI investment returns were to reduce to the level of CPIH, this would reduce APS’s currently strong funding position.
While pension increases for NAPS are set at CPI levels resulting from how the scheme was structured when first introduced, the loss of RPI investment returns would decrease NAPS funding significantly even if implemented at the latest possible date of 2030. This would increase the existing large deficit, requiring additional cash contributions from BA at a time when the sponsoring employer is already under acute financial stress resulting from the Coronavirus outbreak.
The precise financial figures for the effect on each scheme are redacted in the publicly available responses but ABAP expects them to be giving both Trustees cause for concern.
The APS Response
In the words of the APS Trustee’s response, which ABAP heartily endorses:
“We note that the consultation does not seek views on whether the proposal should be implemented but, on behalf of our 21,000 members, the APS Trustee is very firmly of the view that the proposal should not be implemented as it represents an unjust change in inflation linkage of index-linked gilts (“ILGs”) that consequently undermines trust in the issuance of ILGs by the UK Government. Furthermore, the proposal affects the pension increase calculation for APS pensioners and for millions of pension scheme members across the UK, resulting in a significant transfer of wealth away from pensioners.”
The APS Trustee proposes this to avoid negative impact, with which we strongly agree:
“We prefer that the proposed RPI reform is abandoned. If it is not abandoned, we would encourage the Government and UKSA to consider an alternative approach to redefining RPI, whereby RPI = CPIH + x (these variables are all annual growths), where the margin x is to be agreed based on a fair value assessment of the evaluated difference between RPI and CPIH annual growths. This would :
- avoid the negative impact referred to above ;
- help to mitigate the adverse impact on investors from receiving lower income streams from their assets than expected (including defined benefit pension schemes and their millions of members in the UK);
- maintain the integrity of, and confidence in, the gilt market and avoid unintended value transfer, such that defined benefit schemes, APS included, would continue to be willing purchasers of issuance of ILGs in future;
- avoid dislocation and unintended consequences in other RPI-linked contracts, including inflation swaps, RPI-linked corporate bonds and other commercial and property contracts with RPI-linkages; and
- – achieve the Government’s stated aim (of addressing the statistically inaccurate RPI methodology) but also ensure that there is no unfair transfer of wealth.
Should the proposal go ahead, it should be no earlier than 2030 (to reduce the wealth transfer from pensioners and others). This would however still lead to a materially negative impact on APS and its 21,000 pensioners .”
The NAPS Response
The NAPS Trustee proposes the same redefinition of RPI to avoid negative impact and also highlights the need to avoid unfair transfer of wealth; it has the same bullet points as the APS response above. The response goes on to say:
“Should the proposal to replace RPI with CPIH go ahead, we would favour implementation in 2030 which would lead to a slightly lower, but still materially negative, impact on NAPS and its 63,000 members.”
ABAP endorses and strongly agrees with the NAPS Trustee’s response.
There is unanimity in the two Trustees responses that the proposals contained in the consultation are harmful to APS & NAPS, to the two schemes combined membership of 84,000 and to the UK defined benefit pensions industry in general.
It is reasonable to ask is why both schemes have based funding on RPI level investments. It’s simply because both APS & NAPS must hedge their inflation risks. This is in line with investment guidance issued by The Pensions Regulator in 2019 to trustees of defined benefit pension schemes. CPI level investments are not as available or cost-efficient as RPI level investments. It is also worth noting that in response to a UKSA consultation on inflation indexation in 2015, the Treasury responded thus: “The Government remains committed to using RPI e.g. in existing index-linked gilts which currently run out to 2068”, firmly indicating a continuing commitment to RPI.
ILGs are still only issued by reference to RPI. APS & NAPS currently hold around 1% of all the ILGs issued, which in terms of the marketplace, is a very significant holding indeed.
ABAP’s view is that aligning RPI with CPIH will replace a well-understood measure of inflation, one which has been used for over half a century by both parties to negotiations, as the basis of contracts and monetary promises for the future, with a measure which consistently has an annual increase around 1 percentage point lower than the annual RPI increases. This leads to the severe compounded detriment to not just APS and NAPS and their members but to all defined benefit pension schemes and pensioners. The diagram below vividly shows the impact of changing indexation on an APS pension of £10000. For example, if the RPI reform is implemented in 2025, the cumulative loss on £10,000 a year in 2025 would be about £20,000 by 2045; this loss reduces to about £11,000 if the reform is implemented in 2030, a smaller amount but still a severe loss. This same proportion of loss would equally apply to APS & NAPS investments forced to move from RPI to CPIH but naturally on a much greater scale, leading to a decrease in each scheme’s funding, and particularly for NAPS, a larger deficit.
The best option is for no change to take place to RPI.
However assuming the proposals are implemented as per the consultation and RPI becomes CPIH, the later date of 2030 is preferable for APS & NAPS, as this reduces financial damage to pensioners and allows more time for adjustment to investment strategies.
If RPI is to be replaced, it must be by a measure that allows for CPIH plus an acceptable margin. If this is not done, purchasers of ILGs will justifiably consider that they are due compensation as these investments were made in good faith based on previous assurances from the UK government.
NAPS & APS members have made tough practical choices to ensure that their retirement was sufficiently funded. If the government were to now undermine those choices and also undermine the schemes in which they are members, the message would be that government-backed ILGs are not to be trusted. This will have far reaching effects for the economy at a time when the government will need to attract investment.
What action you can take
Firstly, you can make an individual response to the consultation, saying that as a NAPS or APS member, you support and endorse your respective Trustee’s response. You can also add your own views using the information provided above. The documentation provided in the consultation website is rather technical so the key points you could make are
- The proposals in the consultation represent a transfer of wealth away from pensioners to the government
- No change to RPI is the preferable option
- If there is to be a change, then the latest possible date of 2030 is preferable
- The adverse impact of the change must be avoided by the provision of an equivalent measure of RPI increase = CPIH increase + a margin based on a fair value assessment of the previously expected difference between RPI and CPIH increases.
Written responses can be made to these addresses:
|RPI Consultation Team
1 Horse Guards Road
London SW1A 2HQ
|RPI Consultation Team
Office for National Statistics
Newport NP10 8XG
Secondly, you should engage with your MP to make them aware of the consultation and its impact.
Many MPs will be new to their role following the December 2019 general election. You can find out who your MP is by using: https://www.theyworkforyou.com/mps/
While a response to the consultation can be more detailed, we recommend that a communication to your MP be kept simple as this tends to be more effective as they have competing demands on their time. We suggest the following structure but you can use the information provided to make it more personal, this will be more effective, especially if you can outline how you would personally be affected:
Dear (MP’s name)
On 11th March this year, the Government launched a consultation on the Reform to Retail Prices Index (RPI) Methodology. The proposals in the consultation would be damaging to my British Airways pension scheme and also the wider UK pension industry.
The consultation assumes that RPI will be aligned with CPIH and seeks opinions on when this change should occur – 2025, 2030 or anytime in between. The consultation admits than neither the Government nor the UK Statistical Authority (UKSA) has full knowledge of the impact of the proposals.
I am asking for your support to persuade the Chancellor of The Exchequer that RPI should remain as an inflation index but, if the proposals do proceed, the Government and UKSA must adopt an alternative approach to redefining RPI, where RPI growth = CPIH growth + a margin based on a fair value assessment of the previously expected difference in growths between RPI and CPIH. This would protect investors and pension schemes from the severely negative impact of these proposals which would in effect be an unfair transfer of wealth from millions of UK pensioners to the government.
A £10,000 p.a. RPI-linked pension would suffer a cumulative loss of £20,000 by the year 2045 if these proposals were implemented in 2025. A later 2030 implementation would see this loss lessen to £11,000, still a significant amount. 21,000 members of BA’s Airways Pension Scheme (APS) would be affected by these proposals as they have an expectation of RPI annual increases.
Although BA’s New Airways Pension Scheme (NAPS) uses CPI for its annual increases, the impact for NAPS would be to reduce the funding of the scheme. NAPS has 63,000 members relying on their scheme to pay the pensions promised to them. NAPS is not yet at a point that could honour that promise.
The loss of RPI would affect the APS & NAPS scheme funds, seriously weakening their funding positions. Currently, NAPS has a large deficit (£2.4bn) on which it is dependent on BA to make good, at a time when the company is under financial stress from the Coronavirus crisis. The proposals in the consultation would increase that deficit. Both APS & NAPS have extensive investments in government backed index linked gilts (ILGs) made on an RPI basis. RPI investments are made as a hedge against inflation – as defined benefit schemes were advised to do by the Pensions Regulator in 2019. If the government were to now undermine this advice by effectively removing RPI, the message would be that government-backed ILGs are not to be trusted. This will have far reaching effects for the economy at a time when the government will need to attract investment.
The trustees for both BA’s defined benefit pension schemes (APS & NAPS) have responded and are unanimous in their view that aligning RPI with CPIH will have severe adverse effects to the schemes and their members. They go on to say that these adverse effects will be felt across the entire defined benefit pension sector. The responses can be found here:
I hope you can give your support to this matter which has the potential for far reaching adverse effects across the UK pensions industry. It’s important that this issue does not get overlooked in amongst the various financial responses to the coronavirus crisis.