On 4 September 2019, the UK Statistics Authority (UKSA) announced plans to align RPI with the CPIH measure of inflation (which should be similar to CPI) no later than 2030. The Chancellor has said that a consultation on whether to allow the change to be made earlier – potentially from 2025 – will be launched alongside the Budget on 11 March 2020.
Since that UKSA announcement, many companies have been considering the implications for how to set their inflation assumptions when calculating the accounting value of their defined benefit pension liabilities. Much of these discussions hinge around whether to adjust market indicators to still obtain a reasonable indicator of future levels of RPI inflation, and how much of a gap to assume between the RPI and CPI measures of inflation in the future.
What we have found so far is that large pension schemes typically made a limited allowance for proposed changes to the Retail Prices Index when preparing their end of 2019 accounts. Assumed RPI inflation fell by around 0.25% across all scheme liabilities, in line with market movements over 2019. However, assumed CPI inflation, which is typically set relative to RPI inflation, remained broadly constant. The average gap between assumed RPI and CPI inflation over the term of the pension liabilities therefore reduced to 0.8%, from 1.0% a year earlier. Assumptions for the gap varied from 0.6% to 1.1%. This is based on an analysis of the assumptions made by our clients who are either in the FTSE100 or have pension liabilities above £1 billion and who had financial years ending 31 December 2019.
Neither financial markets nor UK plc appear to be reflecting full convergence of RPI and CPIH beyond 2030, in spite of the UKSA’s announcement. Different companies have taken different approaches, partly driven by auditor views. We might see a further reduction in RPI-linked pension liabilities next year if it becomes clearer that the change will go ahead without pension scheme members being compensated. Even where liabilities come down, what happens to deficits and surpluses will also be affected by how well hedged schemes are and by what the changes do to the value of RPI-linked assets.
We’ll be factoring the developments in RPI and CPI inflation-setting into our Pension Deficit Index in the spring once we have analysed the published 31 December 2019 accounts of the FTSE350 companies.