More on the RPI Alignment Consultation

Our former Chairman, Capt. Mike Post, has written the following regarding the proposals to align RPI & CPI.  Although the consultation has now closed, we feel that it’s important to keep the issue in the minds of our MPs, as we await the result of the consultation.  The impact of Covid on the financial landscape will inevitably be huge and this particular issue is one that should not be overlooked.

Dear All

Earlier this year ABAP and I were  in contact to  ask for individual responses to be made to the Government’s and the UK Statistics Authority’s Consultation on the proposed Reform to the Retails Prices Index Methodology and also for representations to be made to MPs. As you will remember, the Consultation closed in August.

I have been privileged to have received copies of numerous letters  from MPs in reply to their constituents letters raising concerns about the RPI consultation.  Unfortunately, perhaps because they have other matters on their minds,  many of the MPs or their assistants seemed to have replied with letters containing identical or near-identical paragraphs of waffle which are clearly copied from a central source and are not the result of real engagement by the MPs or their assistants. The impression that is received is that, whilst there is some support for our point of view, there is limited understanding by many MPs of the serious nature of the devastating effects  that the alignment of the RPI with CPIH would have on many millions of pensioners, savers, investors in government debt and consequently the government’s reputation for honest dealing.

Fortunately the Pension and Lifetime Savings Association  (PLSA), which until recently was called the National Association of Pension Funds (NAPF), is a big hitter in this area. The PLSA represents over 1,300 pension schemes with 20 million members and £1 trillion in assets, across master trusts and defined benefit, defined contribution, and local government schemes. The PLSA has, in ABAP’s and in my opinion, produced a devastating consultation response which, if drawn to the attention of our MPs, may wake the MPs and the Government  up to the danger that they are in.

As a reminder, the original Consultation may be found at: https://www.gov.uk/government/consultations/a-consultation-on-the-reform-to-retail-prices-index-rpi-methodology

The PLSA’s consultation  response  may be found at:  https://www.plsa.co.uk/Policy-and-Research/Document-library/Reform-to-Retail-Prices-Index-Methodology

The PLSA’s response fully expresses and expands on the considerable concerns of ABAP and the APS and NAPS Trustees as expressed in their own responses. It is in particular interesting to note that the PLSA draws attention to the fact that aligning the RPI with the CPIH will have a more severe consequence for women and younger pensioners.

The key points raised by the PLSA are included in the Executive Summary on pages 3 to 5 of its consultation response.It is hard to see how any Government would proceed with a change that would lead to legitimate accusations of acting in bad faith. However, the most important practical feature of the list of the PLSA points as they directly affect the payment of pensions to pensioners which have been promised and paid for (twice over in the case of APS) is the statement in the Summary’s tenth bullet point: ”In order to transition away from the use of RPI in a fair and equitable way, we suggest the government and the UKSA deliberately adjust index-linked gilts from RPI to CPIH + X, where X is an agreed and transparently calculated adjustment reflecting the expected long term average future income of RPI over the new inflation measure. This solution is also commonly referred to within industry as “CPIH + a spread”. Alternatively, the Government may also wish to consider paying any future lost income to index-linked gilt holders upfront.”

The PLSA has £1 trillion in assets and  represents 1300 pension schemes with  20 million members. Perhaps  sharing the PLSA’s consultation response with our MPs will alert them to the electoral minefield they will be entering if they fail to take on board the views of the PLSA, the APS and NAPS Trustees and the views of the members of the Association of British Airways Pensioners.

May I therefore ask that you send the following or similar communication to your MP, suitably amended for your personal circumstances:

Your address

Dear  (MP’s name) MP

You will recall that in 2019, after a legal battle lasting years which cost BA around £30 million, an agreement was approved by the High Court for a return to the payment of RPI increases to APS pensions.

I am writing to you again about the Government’s and the UKSA’s (UK  Statistics Authority’s) Consultation on the proposed Reform to the Retails Prices Index Methodology which closed in August. The Consultation made no reference to the payment of compensation to the potentially many millions of losers who have paid in good faith for their RPI-protected pensions and investments when the RPI has been calculated using a consistent method for over half a century. Having themselves acted in good faith they will correctly conclude that they have been swindled by the Government if no compensation is paid.

The Consultation may be found at:

https://www.gov.uk/government/consultations/a-consultation-on-the-reform-to-retail-prices-index-rpi-methodology

I appreciate that you have many other issues to address at present but it seems to me that many Members of Parliament are currently unaware of the self-inflicted damage that will be caused if a change to the methodology of calculating the RPI is made without provision being made for compensation. There is a risk of a serious injustice affecting millions of people.

I should like to draw your attention to the comprehensive consultation response by the Pensions and Lifetime Savings Association (PLSA), which until recently was called the National Association of Pension Funds (NAPF). The PLSA represents over 1,300 pension schemes with 20 million members and £1 trillion in assets, across master trusts and defined benefit, defined contribution, and local government schemes.

The PLSA’s consultation  response  may be found at:  https://www.plsa.co.uk/Policy-and-Research/Document-library/Reform-to-Retail-Prices-Index-Methodology

The PLSA’s response fully expresses and expands on the serious concerns of the Association of British Airways Pensioners (ABAP)  and the Airways Pension Scheme (APS) and the New Airways Pension Scheme (NAPS) Trustees as expressed in their own responses. It is of note that the PLSA draws attention to the fact that aligning the RPI with the CPIH will have a more severe consequence for women and younger pensioners.

It is pertinent that HM Treasury’s response to the UKSA’s consultation in 2015 on “Measuring Consumer Prices: the options for change”,  signalled its continued support for RPI, noting “The Government remains committed to using RPI e.g. in existing ILGs which currently run out to 2068”.

The key points raised by the PLSA are included in the Executive Summaryof its response which I append below. It is hard to see how any Government could proceed with a change that would lead to legitimate accusations that it had  acted in bad faith. However, the most important practical feature of the list of the PLSA points as they directly affect the payment of pensions to pensioners which have been promised and paid for (twice over in the case of BA’s APS pensioners) is the statement in the Summary’s tenth bullet point:

”In order to transition away from the use of RPI in a fair and equitable way, we suggest the government and the UKSA deliberately adjust index-linked gilts from RPI to CPIH + X, where X is an agreed and transparently calculated adjustment reflecting the expected long term average future income of RPI over the new inflation measure. This solution is also commonly referred to within industry as “CPIH + a spread”. Alternatively, the Government may also wish to consider paying any future lost income to index-linked gilt holders upfront.”

May I urge you to encourage the Government to:

Abandon the proposed RPI reform.

If the reform is not abandoned, will you please  encourage the Government and UKSA to consider an alternative approach to redefining RPI(as advocated by the PLSA), 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 incomestreams 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 unintendedvalue 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.

If the  proposal does 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 NAPS and their 22,000 and 63,000 members respectively.

The current uncertainty around whether any changes will be made and, if so, where within the 5-year implementation window, will lead to pricing anomalies and a lack of investor confidence. It is suggested  that the timing of any changes should be transparent and communicated without undue delay. The UK Government needs to avoid the poor communication and ensuing confusion and litigation that followed the announcement of the raising of the Women’s State Pension Age from 60 to 65.

Finally, it would expected that there will  additional consultations in the future, depending on the outcome of this Consultation, to address any unintended consequences of the proposal.

The consequence of failing to find an equitable solution would be severe. I trustthat you will be able to support the above proposals which are in line with the thinking of the PLSA and  the APS and the NAPS Trustees.

Yours sincerely

(name)

EXECUTIVE SUMMARY of the PLSA’s response to the Treasury’s and UKSA’s Consultation on the Reform to the RPI Methodology

  • The PLSA welcomes the opportunity to respond to the joint consultation from the Treasury and UK Statistics Authority (UKSA) on proposed reforms to the RPI methodology.
  • The PLSA understands that RPI is a flawed measure of inflation, and supports plans to develop a more robust measure. However, we caution that if the Government takes the decision to proceed with aligning RPI with CPIH as planned, it must also take steps to mitigate the detrimental impact this change will have on holders of index-linked gilts, of which pension schemes are the predominant investors, as well as those who will be impacted as a result, namely pension scheme members.
  • We strongly believe that the implications of the change must be addressed in a way which allows various stakeholders to provide input to determine the most equitable way to transition away from RPI. A precedent has already been set for reforming benchmarks, as in the case of LIBOR, where a Working Group was established to ascertain that the transition to the replacement index, SONIA, minimised the impact on stakeholders. We believe the government should consider implementing a similar approach.
  • Depending on the timing of the changes, pension scheme members will lose between 4-9% of their pension value. The yearly average DB income with RPI uprating of a man aged 65 in 2020 is predicted see a drop of 17% if changes are made in 2025 and women aged 65 will see a drop of 19%. If the change is made in 2030, a man would see his yearly average income fall by 12%, while a woman would see her income reduce by 14%. (1)
  • Aligning RPI to CPIH is likely to exacerbate problems with the gender pension gap and intergenerational fairness, due to women and younger members being the most detrimentally effected by the change. This will increase the disparity in pension wealth at a time where these groups – which are already known to be more financially vulnerable due to pay gaps and their reliance on flexible and part-time work – face increased uncertainty.
  • DB pension schemes will be significantly impacted if the government decides to go ahead with the change. Currently, they invest an estimated £470bn in index-linked bonds, with 29% of private sector scheme assets invested into index-linked bonds. A simple switch to CPIH is expected to reduce the value of these pension scheme investments by £80bn if done in 2025, and £60bn if made in 2030 (2) (3). This could lead to some DB pension schemes closing to new entrants or future accrual to help address this loss, meaning that, ultimately, scheme members are worse off.
  • The impact of the change on funding levels will be of particular concern to DB pension schemes at a time where there is already much uncertainty. Currently, schemes are potentially facing significant impacts on funding levels arising from COVID-19 and TPR’s new DB Funding framework. It has been estimated by the Pensions Policy Institute that for pension schemes who use RPI-linked gilts to hedge CPI liabilities, for every £10m invested, they would see a loss of £1m in asset value if the changes are made in 2030, this figure doubles if the change is made in 2025. A significant fall in the income received from RPI-linked gilts would lead to a reduction in scheme funding. This funding gap would require higher contributions from employers, which may be difficult to achieve, particularly for sectors significantly impacted by COVID-19.
  • Depending on the date of the change, these reforms’ could result in a large wealth transfer of approximately £90bn (4) from those who hold index-linked gilts – the majority of which are UK pension schemes and insurers – to the UK government. The government must therefore be as transparent as possible as to where this wealth will go, and who will benefit from this transfer.
  • We believe that trust in pensions schemes and the government will be potentially damaged by these changes. Implementing the changes will effectively cut benefits for many members, which could reflect poorly on both pension savings and the government, despite schemes following a prudent investment strategy on the basis of assurances that RPI would not undergo any substantive changes in the near future.
  • In order to transition away from the use of RPI in a fair and equitable way, we suggest the government and the UKSA deliberately adjust index-linked gilts from RPI to CPIH + X, where X is an agreed and transparently calculated adjustment reflecting the expected long term average future income of RPI over the new inflation measure. This solution is also commonly referred to within industry as “CPIH + a spread”. Alternatively, the Government may also wish to consider paying any future lost income to index-linked gilt holders upfront.
  • Taking up mitigating factors will help to ensure that prudent schemes – that invested in RPI-linked gilts in good faith with an expectation of certain returns which have been factored into funding plans – should not face funding shortfalls as a result of these reforms. There is also no need for savers to be so unduly effected, particularly in the context of financial hardships from COVID-19.
  • We also urge that if the Government does decide to align RPI to CPIH prior to 2030, that on top of mitigation, the changes should be made as close to 2030 as possible. This will be a more viable solution allowing for the establishment of a Working Group for the transition, giving investors in index-linked gilts enough time to prepare while also providing a better outcome for pension scheme members.

1 PPI (2020) “How could changes to price indices affect Defined Benefit schemes?”

2 PPI (2020) “How could changes to price indices affect Defined Benefit schemes?”

3 Analysis from others indicates that this figure for all holders of index-linked gilts could be £90bn if the change is made in 2025 or £120bn if made in 2030. See:
https://www.pensionsage.com/pa/RPI-reform-could-negatively-affect-10-million-DB%20members.php

4 Insight Investment (2019) “Proposed changes to RPI: Nobody needs to lose out”. Please see: https://www.insightinvestment.com/globalassets/documents/regulatory-updates/uk-proposed-changes-to- rpi.pdf

Here is the full text of the PLSA’s response

RPI 2020 consultation - PLSA-response