What a move to CPIH could mean for UK pension schemes

The evolution of consumers’ ‘basket of goods’ is one of the most tangible reminders of how spending habits have shifted over time; pensioner members and those nearing retirement will remember a very different nation to the one we inhabit today.

The range of products in the basket, a sample of everyday items used to measure changes in the prices of goods and services, has changed and expanded over the years – from the first basket of around 150 items in 1947 to more than 700 today.

A measure that takes the cost of housing into account has to be a bit more applicable in real terms than one that doesn’t

Marcus Fink, Ashurst

While yoghurt drinks and sat nav systems fell out of favour in 2015, protein powder for the city gym slickers, sweet potatoes for paleo dieters and craft beer for the hipster in all of us made it into the basket for the first time.

Against a backdrop of evolving habits, debate over the measure of inflation that best captures consumers’ experience has wrangled on, complicated by a lack of consensus over the approach most suitable for member states across the European Union.

In the UK, the government currently uses the consumer price index for the indexation of benefits, tax credits and public service pensions, and the retail price index for the uprating of index-linked gilts and revalorisation of excise duties, but change could be on the horizon.

Index switch

The choice of inflation index has become a high profile issue for UK pension funds in the wake of High Court rulings on the Qinetiq and Arcadia group pension schemes.

Where scheme rules allow, trustees are increasingly changing the inflation index used to measure future pension payment increases, a move estimated to reduce the ongoing costs of defined benefit pension schemes by around 1 per cent a year.

Marcus Fink, partner at law firm Ashurst, says trustees either have the index used for revaluations “hard-coded” into their scheme rules or must reference the government’s measure for inflation.

A shift in government practice for measuring inflation would set the bar for this latter group of schemes – a move Fink says could add more “bad news” to the list of onerous demands for many corporate sponsors.

Momentum is gathering behind a move to CPIH as the preferred government measure.

The ONS has said the continued absence of owner occupier costs within CPI is a “weakness” as it fails to reflect the impact of housing costs – which account for approximately 10 per cent of households’ consumption expenditure in the UK, higher than elsewhere in the European Union.

In January 2015 the UK Statistics Authority published the findings of an independent review of UK consumer price statistics by Paul Johnson, director of the Institute for Fiscal Studies.

In the report, Johnson encouraged “the ending of the use of the RPI as soon as practicable” and recommended the adoption of CPI, including owner occupiers’ housing costs, as the main measure of inflation.

In a recent letter to the chair of the UK Statistics Authority, John Pullinger, the UK's national statistician, said he is “inclined to consider that CPIH should become the ONS-preferred measure of consumer inflation”.

Fink says a shift to CPIH, currently running slightly higher than CPI, would “straight away increase liabilities”, potentially “very bad news” for scheme sponsors.

Conversely, a shift to CPIH would be good news for members. “A measure that takes the cost of housing into account has to be a bit more applicable in real terms than one that doesn’t,” Fink says.

Debt issuance

Richard Gibson, associate at consultancy Barnett Waddingham, says the adoption of CPIH as the government’s preferred measure would not make it the single measure but would raise questions about debt issuance, currently linked to RPI.

“If the ONS comes out of this study saying CPIH is the preferred measure, that gives the Treasury time to think again and to say, ‘Should we now be issuing debt linked to CPIH?’,” he says.

Debt issues pegged to CPIH would be “very welcome practice” for pension schemes, Gibson says.

“Many of their benefits are linked to CPI and it would be far easier to hedge their risk if they had access to government bonds linked to CPIH.”

PPF quirk

Beyond the impact on individual schemes, Fink says a shift in the index could have some serious implications for the Pension Protection Fund – the UK pensions’ life raft – which revalues compensation payable to members on the basis of CPI.

Still a relatively young organisation, Fink says the already “colossal differential” between assets and liabilities would open up significantly due to the sheer number of compensation recipients.

“The gap between assets and liabilities will widen further still, at a time when many commentators are concerned and really questioning how the PPF can realistically narrow the gap,” says Fink.   

Out with the old

Pullinger actively discourages the use of RPI as a measure of inflation in his letter, indicating plans to phase out the publication of non-essential data from 2017.

The intention to further develop the HII, a payments index that indicates the effect of changes in payments for goods and services, is also made clear.

It begs the question whether trustees who are following the letter of the law in their rules and are using a nonsense index calculation may want to consider changing it

Richard Farr, Lincoln Pensions

A useful vehicle for tracking the different households’ experience of changes in prices, Pullinger says HII presents an “idea that is fundamentally different to the traditional measurement of consumer inflation”.

“I believe the potential of a HII is to provide information that will be valued by users and provide an important complement to our measures of consumer inflation,” he says.

Richard Farr, managing director at covenant specialist Lincoln Pensions, says RPI is “an archaic remnant from the past”.

“It begs the question whether trustees who are following the letter of the law in their rules and are using a nonsense index calculation may want to consider changing it,” he says.

Many trustees have so far resisted this change on the grounds of scheme rules, but Farr says a shift in government policy on inflation should warrant further consideration of the issue.

“If it’s clear from the government that the actual measure is no longer meaningful, how can you use it?”

But trustees who have already made the switch into CPI may want to hold out on further changes until future government policy on inflation becomes clearer. “The jury’s out.” says Farr.