The Retail Prices Index (RPI) will be reformed and aligned with the housing cost-based version of the Consumer Prices Index, known as CPIH, by 2030, the Treasury has confirmed.

As part of the Comprehensive Spending Review today (25 November), the government announced that the methods and data sources of CPIH would be brought into RPI in February 2030, after the date of the maturity of the final specific index-linked gilt that year.

While the Treasury had consulted on making this change as early as 2025, in the response published today chancellor Rishi Sunak said he would withhold the consent necessary before 2030 in order to minimise the impact on the holders of index-linked gilts.

Nevertheless, the government has refused to offer compensation to index-linked gilt holders, noting that there would be no change to the contractual terms with RPI still being used to determine the index ratio.

As the consultation closed to responses in August, it was warned that investors could face a fall in asset values of up to £130bn depending on the breadth and pace of the reform.

The Pensions Policy Institute predicted a £60bn hit to scheme investments of a 2030 implementation date, while the Pensions and Lifetime Savings Association estimated a 17% drop in income for a man aged 65 this year if the change was made in 2025.

'Major blow'

Hymans Robertson partner Matt Davis said the decision was a "major blow for pension schemes and their members", although noted that the impact will vary significantly based on each scheme and its rules.

The government said it "keeps the occupational pensions system under review and will continue to do so", noting the particular impact on some scheme members whose benefits are pegged to RPI.

Davis said this was a "crumb of comfort" and added: "Pension schemes that have followed regulatory and industry best practice by hedging the inflation risk inherit in providing pensions are major holders of index linked gilts and other RPI-linked assets. This change means RPI-linked assets are expected to increase at a lower rate than previously anticipated, which makes them less valuable than before. The schemes that will be worst affected are likely to be those with high levels of inflation hedging and a high proportion of CPI-linked pension increases. In some cases these schemes could see a 10% fall in funding level. The Government has stated it will not offer compensation to holders of index-linked gilts which will have a huge detrimental impact.

"We expected this to have a very significant effect on investors as a whole. We estimate that the impact on the totality of index-linked gilt holders will be a loss in the region of £100bn based on past differences between RPI and CPIH. Given the vast sums of money involved we expect to see continued pressure on the government to review its decision not to compensate those due to lose out."

Insight Investment head of solution design Jos Vermeulen said he was disappointed with the government's decision, believing the approach to be inequitable. He said: "This is expected to reduce the future change in RPI from 2030 onwards by 1% per annum, effectively transferring around £100bn of value from index-linked gilt holders (largely pension funds) to the government.

"This decision has been made despite substantial concerns being raised during the 2020 consultation, from a broad range of market participants. Insight worked to raise awareness of this issue, as although we understand the statistical problems of maintaining RPI as a legacy index, we do not believe that a solution should result in large transfers of wealth.

"Another chapter in the RPI saga has drawn to a close, but with ten years until the decision is implemented, we struggle to believe that this is the final chapter, and we will continue to advocate for an equitable solution."

'Another lottery'

And while the response is in the large part expected, Society of Pension Professionals president James Riley said the variation in scheme impacts would be stark: "The outcome of the consultation is largely as expected bringing RPI in line with CPIH by 2030. This removes one of the many uncertainties hanging over pension schemes currently and, at one level, this certainty is helpful.

"However, it's yet another lottery, alongside others including GMP equalisation, that affects otherwise similar schemes and sponsors differently. Schemes' RPI assets such as index-linked gilts and inflation swaps will be adversely impacted. Will the reduction in the scheme's liabilities be greater? And then of course, there are pension scheme members, many of whom, rightly or wrongly, will receive lower pension increases than they might otherwise have expected."

Mercer partner and chief actuary Charles Cowling said it was important that schemes now sought to understand the impact: "RPI is clearly a flawed measure of inflation and replacing it to ensure future pensions are calculated fairly is the right thing to do. Unfortunately, doing so will inevitably create both winners and losers, though arguably the impact will already have been priced into the market to some extent.

"For companies and trustees it is now crucial that they seek to understand the impact on their schemes so they can explain and communicate this clearly to their members. On the investment side, there is an opportunity to review hedging programmes to make changes that might lessen the impact of the switch."

Published inLatest Insights

The discovery of a covid-19 vaccine should mean good news to the whole world as it means everyone and everyone gets to go back to what was once considered normal. But this return to normalcy is a blessing to some and a curse to others. Surprising right? Who would have thought that such welcomed development would be adverse to some industries and sectors, one of which is the investment asset classes?
Gold, equity, and debt funds are investment classes that may not fare very well in the wake of a normalized world. This is how the investment classes would perform and what you should do in preparation for any eventuality.

No asset class can move in a straight line in perpetuity, and the pandemic has hugely supported the price of gold. It is only logical to expect that the price will correct and go back to what it used to be when there is no pandemic.
The price of gold hit its highest on 7th August as the pandemic raged on, but there was a decline when the announcement for the discovery of a newly approved vaccine.

The equity market has experienced lots of ebb and flow during the pandemic. By March it fell from a peak that was recorded in January. There has been a healthy recovery between March and August. With equity, it is expected that it will react positively to an approved vaccine's news but not for long.
The eventuality of a vaccine being released and approved for covid-19 has already factored by the market even though there is no certainty of when it will be released. Investors' advice is that investors stay true to their asset allocation if they must navigate the volatility.

The predicted immediate response for debt investments is an increase in bond yields because central banks may not have a need to buy bonds. According to a fund managers, central banks will not quickly hike the interest rates even though they stop buying the bond yields.
It is also expected that some debt products like bank fixed deposits are expected to keep providing low-interest rates even though interest rates are not likely to rise in the near future.
The topmost priority for most governments around the world is to discover a vaccine for the coronavirus in the shortest time possible. The result of an eventual discovery and approval of a vaccine is volatility in a lot of investment asset classes. It is best that to navigate these times; you should employ and heed the advice of experts. This would help you to make sure that you invest in the appropriate products.


Published inLatest Insights
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