RPI, CPI or conditional indexation?

The move has been seen by many as a way of giving some relief to battered defined benefit schemes, which struggle to make ends meet. But the move has been labelled a “nightmare” by a group of high-profile trustees, including Philip Read, chairman of British Coal pension trustees.

The CPI – which excludes housing costs – is typically lower than the RPI. And if RPI is replaced by CPI as the basis for the minimum inflation increase for private schemes, the effect is likely to be lower pension payments.

Over the past 10 years, CPI was lower than RPI for every year but one. Jeroen van Bezooijen, senior vice president at Pimco, said the proposed changes could reduce the value of employees’ future retirement benefits by up to 10%.

Besides the negative effects for pensioners, the measures appear to be difficult to apply for several pensions schemes. While some trustee deeds allow applying the minimum legal indexation levels, others specifically bind the scheme to the use of the RPI.

The Netherlands – a country which still maintains a high number of defined benefit (DB) schemes, in contrast with the rest of the western world – has more flexible provisions in terms of indexation.

Conditional indexation allows schemes to individually decide on a yearly basis whether to apportion part of the inflation increase, all of it or none at all.

Tim Reay, principal at Hewitt international benefits team, said: “When the fund has not done well financially or the sponsor is doing really badly, you can decide not to increase benefits in line with inflation – instead of shutting the DB plan – with the perspective of catching up in the future, if circumstances allow for it.”

In the past two years, Dutch schemes have used this provision in an attempt to improve their funding ratio, which the crisis severely eroded.

Industry figures have different opinions on which if the two approaches would be more beneficial to the UK industry.

On the one hand, the Dutch way allows for more flexibility. On the other, there is no denying the purchasing power protection of pensions is better guaranteed in the UK.

However, both options rely on the reduction of pension payments.