The Big Question

What impact do you feel the change from RPI to CPI to calculate pension payments will have?

Peter Carter is head of product marketing at MetLife UK

For employers who have been struggling in recent years under the burden of funding defined benefit pension schemes, the DWP’s announcement that it would now use the Consumer Prices Index to calculate increases instead of the Retail Prices Index is probably a very welcome one.

A combination of legislation, increased regulation, rising longevity and uncertainty about rising costs have been seen as the underlying factors behind many scheme closures.

The key difference between the RPI and the CPI is that RPI includes housing costs such as mortgage interest payments. Given that most pensioners will have paid off their mortgages it is clear that housing costs are less relevant, and the CPI would therefore appear to be a sensible basis for calculating annual increases.

Jamie Clark is business development manager at Scottish Life

One, it could lead to a transfer ‘fire sale’. Generally, increases with RPI are more generous than increases with CPI. One consequence of the change may be more members transferring their benefits from final salary schemes ahead of the point where the scheme formally adopts the new rules, so as to get higher values.

Two, a ban on transfers. It has already been reported that public sector schemes have effectively banned transfers until guidance is given, and digested, as to how transfer values should be calculated. Trustees of private DB schemes may need to consider adopting this approach to prevent a ‘fire sale’.

And three, with the added cost of auto-enrolment on the horizon, employers will be looking to further mitigate any DB liabilities and costs. The change to CPI should make winding-up cheaper. So we could see more employers winding up DB schemes as this option becomes more affordable.

See link for details of public sector ban: www.civilservice.gov.uk/my-civil-service/pensions/June-Budget-CETV.aspx

Rob Evans is senior consultant at Buck Consultants

Over most historic periods RPI has been higher than CPI. Businesses will no doubt be pleased to see their pension costs reduced, but pension recipients will be dismayed that their benefits will be increasing at a lower rate.

It is worth noting though that not everyone will be affected. Many schemes’ rules require the use of RPI, and employers can always choose to be more generous, so there are no doubt some lively discussions to be had between employers and their scheme members!

It is deferred members in defined benefit plans that, potentially, will see the largest change to their benefits. A 35-year old leaving service with a £5,000 benefit that links to CPI both before and after retirement could see a pension of £15,200 at age 80, compared to £21,000 if RPI had been used.

Reduced benefits mean reduced costs for pension scheme sponsors. For this reason we expect the businesses supporting defined benefit pension schemes to be watching future announcements very closely.

Andy Gadd is head of research for Lighthouse Group
Although we are always told that past performance is no guarantee of the future it is interesting to compare the September RPI and CPI figures from 2000. In both 2008 and 2009 CPI was higher than RPI

Pension Capital Strategies has put the level of the saving as a result of this change at £100 billion for FTSE 100 companies, which will undoubtedly be welcomed in boardrooms across the land. The problem for me however, is the negative publicity that this change has generated for the millions of individuals who are not funding enough for their retirement and now have the perception that even if they do save into a pension then the benefits can simply be cut by the Government changing the goalposts so why bother at all. It has just made an IFA’s job that bit more difficult.

Steve Groves is chief executive of Partnership

I am generally supportive of the need to drag down the cost of pensioner liabilities; the average baby boomer will take out £1.20 for every £1 they put in over their lifetime, clearly that is unfair on the subsequent generations who will pay for it.

However, pensioners spend more as a percentage of income on council tax, insurance etc. than most and less on consumables. We are therefore increasing the extent to which their income will behave differently to their expenditure and the risk they are left unable to cope.

It is also a difficult change for pension funds to manage. Index linked securities link to RPI, if CPI is greater than RPI there is a risk they don’t have adequate investment returns to cover the liabilities as they fall due.

There are several issues that need to be considered by schemes, particularly with regard to their own rules, but many FTSE 100 companies could potentially reduce their IAS19 liabilities. The estimate of £100 billion might be overly optimistic but the reduction could still be material.

Lobby groups have argued that this change is unfair. There are, however, winners and losers in many scenarios, lots of which do not result from explicit changes to rules and regulations. For example, if inflation takes off there will be a general shift in wealth from savers to borrowers and from the retired to the non-retired. Many will see this as unfair. With finite resources, a huge debt burden and the pension sector in crisis, decisive action is needed and the Government’s actions do seem encouraging.

Anthony Morrow is commercial director at Perspective Financial Group

Certainly for those organisations that still offer their employees final-salary benefits this could help ease their liability worries as the ‘cost’ of providing the pensions will fall. This fall in costs means that for the employee a direct result is both a decrease in the level of pension they can expect to enjoy during their retirement and also the amount by which that pension will increase during retirement. On a wider level the move will certainly not improve the public’s perception of pensions and the value they can derive from them. I would also imagine that those who are affected immediately by such a change will be feeling, at the very least, a bit miffed at the changes being made now. What we can see from this change is the constant need for professional advice when it comes to pensions; one would hesitate to suggest that pensions are being used as a political football however the fact remains that we have seen almost continuous change in this area for a very long time. Therefore, seeking the advice of a professional pension adviser on a regular basis should be a pre-requisite for all.

Karen Parry is head of policy and compliance at The Pensions Trust

Linking benefit increases to CPI and the resulting reduction in liabilities is undoubtedly good news for pension scheme sponsors. Although The Pensions Regulator’s statement that he expects the change to result in shorter recovery periods rather than lower contributions may have tempered the celebrations somewhat.

One positive outcome could be that sponsors decide they can now afford to keep their scheme open to future accrual, although the march to DC is now so well advanced that this is probably unlikely.

The change essentially reduces benefits that have already been earned by work done. This does not sit well with the principle that pensions are deferred pay.

What is true is that individuals will suffer a reduction in their income at retirement and will have to decide whether to save more in order make up this difference, work longer or accept a lower standard of living in retirement.

Peter Sayers is a research actuary at Xafinity Consulting

For public sector pensions, a lot. But for private sector defined benefit ones – it depends! What is important is the actual wording within scheme rules.

If these simply refer to the relevant legislation – the Pensions Act 1995 for pension increases, the Pension Schemes Act 1993 for deferred pension revaluation – the CPI will automatically apply. As CPI-based increases are generally – but not always – below RPI ones, scheme members are likely to be worse off.

However, if the scheme rules explicitly refer to the RPI as the basis for pension increases or revaluation, this will continue to be the case. Pensioners will still get the same increases as before. Some deferred pensioners could even be better off, through receiving the higher of scheme-based RPI and statutory-minimum CPI revaluation.

Ben Shaw is development director at Occupational Pensions Trust

Although this change will not affect all schemes, I think it is potentially the first step to be taken by this new government that recognises DB schemes have been pushed too far by legislation. In effect it is, in a small way, rolling back the tide of impositions on DB pension schemes that have included expensive extra guaranteed benefits such as those for spouses and dependants along with indexation and PPF charges.

While I do not realistically expect the government to continue rolling back the tide to cover these other benefits, I do think this may send just the right message to employers that the financial burden will not continue to increase, hopefully making them think twice before closing those relatively few final salary schemes still open.

Let us hope the Government follow this through properly by issuing long-dated CPI-based gilts that will help schemes manage risks more effectively.

Graeme Troy is investment manager – UK Government bonds at Scottish Widows Investment Partnership (SWIP)

Changes from RPI to CPI will depend firstly on the precise deeds and rules of individual pension schemes and secondly the exact detail of the legislation. Given the different wording in various pension scheme rules, it is unlikely a simple universal change to indexation can be applied to all funds

And we need to take into account the bond market - development of a liquid CPI bond market would likely take many years to implement.

What will the changes actually mean? It should ultimately reduce some scheme liabilities, but may need members’ approval for this to happen. For pensioners, there could be a significant impact on retirement income. A potential reduction in proposed income of 0.8% a year may not initially appear substantial but the cumulative impact could knock upwards of 15% off the value of pension payouts.