Recent government announcements are likely to have a significant financial impact on pension scheme funding, the actuarial assumptions used, commutation factors and early or late retirement.
In June’s budget the government announced that it intended for future increases in public sector pensions to be linked to changes in the Consumer Prices Index (CPI). Historically such pensions were linked to increases in the Retail Prices Index (RPI).
A subsequent statement by the Pensions Minister on the 8th July confirmed that the government also intends to use CPI for determining statutory minimum increases which apply to private sector pensions.
The CPI and RPI are both measures of price inflation but there are two main differences.
Both are made up of a ‘basket of goods’. The RPI “basket” includes mortgage interest, council tax, buildings insurance, ground rent and other costs linked to housing. The CPI basket does not include these items, but does have some items not included within the RPI basket.
Historically the CPI basket of goods has, for most time periods, resulted in a lower measure of price inflation than the RPI basket. The differences in how the CPI and RPI are calculate also results in CPI being lower than RPI even if the same “basket of goods” is used.
Most commentators expect CPI to be somewhere between 0.5% and 0.8% lower than RPI, over the longer term. For a typical scheme, closed to future accrual, the value of the accrued benefits could reduce by between 5% and 10% if CPI rather than RPI was adopted consistently for the future.
Many private sector pension scheme Rules refer specifically to RPI rather than the relevant legislation. The impact of the Government’s announcement is far from clear for such schemes; it is possible that the change could actually increase liabilities for such schemes (as CPI may act as a minimum and will be higher than RPI from time to time).
The change in policy is likely to apply automatically to those schemes where the Scheme Rules in relation to pension increases and revaluation refer directly to the overriding legislation and this is not contradicted in other Scheme documentation (such as booklets and announcements).
A review of the Scheme Rules will establish the documented benefits and whether the increases are referred to by reference to the legislation. By seeking necessary legal advice trustees will be able to establish whether it is possible to make the change from RPI to CPI and the impact the change will have before allowing for changes to scheme funding or amending factors. Should the legal advice confirm that it is possible to make the change from RPI to CPI, this will serve to reduce the Scheme liabilities.
Spence & Partners have developed a model which can be used to provide you with an early indication of the likely impact on the value of the liabilities if the changes were to apply to your scheme. Contact our actuarial department to find out more.