News analysis: Will pension inflation index change add up?

Government plans to change the way inflation adjustments on pensions are calculated are causing confusion in the private sector, says Nicola Sullivan

The implications of the government’s plans to change the way inflation adjustments on pensions are calculated remain uncertain and confusing for private sector pension schemes. Pensions minister Steve Webb announced last month that he would switch the inflation index from the retail price index (RPI) to the consumer price index (CPI) – a measure already ratified for public sector pensions. How this change, which is designed to reduce employers’ liabilities, will affect pension schemes will depend on what is outlined in the schemes’ rules.

Many private sector pensions are based on the RPI. Some scheme rules refer specifically to this, which will make it harder for employers to switch to the CPI. Some plans are required to pay whichever index is higher, which could increase their liabilities. Historically, the CPI has been lower than the RPI, but on occasions when the opposite has been the case, schemes that normally use the RPI have been required to switch to the CPI.

Rash Bhabra, head of corporate consulting at Towers Watson, said that unless a statutory override was introduced with the switch, making it easier to change scheme rules, some employers would find themselves having to use the higher of the two indexes, which would increase their liabilities.

“If the way in which this is brought in requires schemes to provide the minimum CPI on statutory benefits, then some schemes [with RPI built into their rules] might find that, for some members, they will have to give bigger increases,” said Bhabra. “For them, that would be outrageous.

“In a significant number of schemes, the rules specifically refer to the RPI rather than what the statute says. It will be pretty unfair for it to be the case that there is this intention to change from the RPI to the CPI, but those employers that happen to have pension scheme rules worded in one way get a benefit and others end up in a worse situation.”

Pensions Regulator’s advice

The Pensions Regulator has advised trustees to prepare for the change by reviewing their scheme rules. It also said employers and trustees should discuss how to respond and communicate with scheme members if the changes were finalised. The regulator also said that because the change would result in reduced pension scheme liabilities, it would mean shorter recovery plans and greater security for members.

Dr Deborah Cooper, head of Mercer’s retirement research group, said: “The government’s proposal to replace RPI with CPI as the measure to determine statutory increases will, in some cases, result in lower increases to pensions in future.

“Trustees should take this into account when considering how liabilities should be financed, and explain the consequences to members. However, it is not appropriate for the regulator to attempt to impose additional security on schemes over and above what trustees consider is reasonable, in agreement with sponsoring employers.”

John Wilson, head of technical services at JLT Benefits Solutions, said the changes could have huge ramifications for defined benefit plans. “Employers need to consider the impact on their scheme right now if they are looking at funding negotiations [or] they may be doing an evaluation process. And if they are looking at liability management exercises, their enhanced transfer offer to members could now be perceived as a bit too generous.”

However, the National Association of Pension Funds said the change from RPI to CPI would be welcome for many schemes. Policy director Richard Wilson said: “It would have been ridiculous if the government changed to CPI around state benefits and public sector benefits and pensions, but private sector employers were not allowed to follow suit.”

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