Steve Webb, the pensions minister, recently announced that statutory pension increases linked to inflation will, in the future, be based on CPI rather than RPI. Given the systematic difference in the way these inflation measures are calculated, one might expect CPI to be on average 0.5% pa lower than RPI over the longer term. The announcement followed the earlier signal in last month’s Emergency Budget.[1]
Final salary pension schemes are required to augment many of the pensions they pay out in retirement along with the ‘deferred’ pensions of former employees by a formula linked to RPI. Over the last 20 years, RPI-based increases have come in at 3.6%, but come the new rules adjusting the minimum increase change to CPI, this would drop to 2.8%. The retail prices index has historically been higher than the consumer prices one because it includes housing costs such as Council Tax.
In the past 20 years, RPI has averaged 3.6 per cent. However, the new rules will see the minimum increase change to CPI, which has historically lagged RPI as it does not include housing costs such as council tax. In the past 20 years, CPI has averaged 2.8 per cent
John Broome Saunders, actuarial director at BDO told The People Bulletin:
‘Half a per cent doesn't sound like much to get excited about, but over the lifetime of a typical pension fund - perhaps 40 or 50 years - it makes a significant difference. Some schemes could see total liabilities fall by up to 10% - which could be enough to halve the scheme's deficit overnight.
‘However it is not yet clear whether all schemes will benefit from this change. Many schemes have a link to RPI written into their rules. It is not clear whether Webb intends to introduce legislation to allow these schemes to make a retrospective change to CPI. If that is the intention, Webb has violated the sanctity of accrued rights. Such a step would make this change a milestone in UK pension history, and would undoubtedly lead to increased pressure from scheme sponsors to allow further retrospective reductions to accrued benefits.’
Broome Saunders went on to explain that the switch from RPI to CPI does not need any enabling legislation – all that will happen is that next time the government makes the announcement of what the increase is going to be in 2011 (which happens each year), it will be indexed to CPI and not RPI. The tricky thing is what happens, if anything, to ‘release’ those schemes that are ‘stuck’ with RPI because that is what is specified in their rules. It is not yet known precisely how many schemes provide for the ‘statutory minimum level of increase’ or actually specify RPI, but it is clear the playing field is not level.
Broome Saunders wonders if, because of this ‘the government might try to make the change by fairer by coming up with legislation that would allow those schemes with RPI hardcoded into the rules to allow those schemes to change CPI. This would require primary legislation and would go against the whole idea of protection of accrued rights.’ He points out that this is very complicated legally because of s.67 of the Pensions Act which covers the modification of accruals. ‘However, with a good lawyer, you might be able to convince trustees to move to CPI while maintaining the spirit of the rules’, he concluded.
[1] See ‘Someone has to pay’ by Diana Bruce in The People Bulletin, 30 June 2010