The Government has now issued its consultation on CPI for private-sector pensions. This raises a number of issues, and asks some challenging questions. One that will certainly generate responses is the question of whether CPI should be imposed on pension schemes, over-riding any references to RPI in scheme rules. This clearly brings the risk – but not the guarantee – of members getting lower pensions and thus seeing their accrued benefits reduced; however, when the alternative involves CPI floors to RPI-linked benefits, it starts to look more attractive.
The consultation sidesteps the issue that members with insured benefits will have different pension increases to those in self-administered schemes, stating that annuities are contracts and any potential changes are an issues for insurers and policyholders. The impact here could well be that the buyout market seizes up until CPI increases have been implemented, potentially reducing the cost of bulk annuitisation. However, a lower cost is not guaranteed.
One area not covered by the impact assessment is the fact that at present there is no risk-free matching investment for CPI-linked benefits. This is not likely to be too great an issue for pension schemes, which typically have much more substantial investment mismatches; however, it could be an issue for insurers providing CPI-linked annuities, including those in the buyout market. The absence of a matching investment could mean that insurers need to charge higher prices to cover the additional risk capital needed to cover the CPI/RPI mismatch. CPI-linked gilts will probably emerge in due course, but it would make sense to consider their issuance at the same time as changes to pensions indexation are under review.
The move from RPI to CPI is likely to be painful and contentious, and I’m not convinced that it will achieve its main aim – to help save defined benefit pension provision. The cost saving to pension schemes, whilst significant, is small in comparison with the increase in the cost of pension accrual from falling interest rates and rising longevity. It is also small relative to the saving that could be found by moving from defined benefit to defined contribution provision. The additional administrative burden that might arise will also do little to help.
Rather than moving the CPI and RPI deckchairs around, a more useful contribution to defined benefit provision would be to create a new type of scheme, light on guarantees and full of flexibility – but that’s a subject for another post…