RPI change to hit DB pension scheme payouts

Private sector defined benefit (DB) pension schemes are facing a drop of between £60bn and £80bn  in assets over the next decade, as a result of the Treasury’s decision to reform the measure of inflation, according to the Pensions Policy Institute

The government has said it will reform the retail prices index (RPI) to align it with the consumer prices index + housing costs (CPIH) methodology between 2025 and 2030, due to flaws in RPI methodology.

The Pensions Policy Institute (PPI) says this move will affect any holders of assets which have a value or return affected by RPI, in particular DB pension schemes, many of which are heavily invested in RPI-linked gilts and other assets and scheme members whose benefits are revalued and/or uprated by RPI.

Daniela Silcock, Pensions Policy Institute (PPI) head of policy research, said: ‘As CPIH inflates more slowly than RPI, schemes invested in gilts will experience a drop in overall scheme assets of around £17m per £100m invested, if the reform is introduced in 2025 and around £13m per £100m if the reform is introduced in 2030. ‘Private sector DB schemes collectively have around £470bn invested in index-linked gilts and could experience an overall reduction in asset value of between £60bn and £80bn depending on when the reform is introduced.

‘Schemes will experience a further decrease in asset value in relation to inflation swaps and other assets with RPI related values and returns.’

Silcock said these effects will reduce funding levels for most schemes, though schemes which inflate benefits by RPI will experience some reduction in liabilities that will compensate for some (or all) of the loss in asset value. The overall effect on a scheme will depend on how much they have invested in RPI linked assets and their level of RPI-linked liabilities.

‘Members whose schemes inflate benefits by RPI could receive up to 9% less overall from their DB pension, an average drop for women (aged 65 in 2020) of around £158,000 to £144,000 over their lifetime, if the reform is introduced in 2025.

‘Women and younger pensioners will experience the greatest reduction as women live longer than men, on average, and younger pensioners will experience a compounding effect.

‘Older pensioners on low incomes will also struggle with a reduction in benefits as they have less opportunity to make up income deficits than younger members,’ she said.

BT, for example, has estimated the net cost to its pension fund as somewhere between £1bn, if the RPI changes are brought in in 2030, and £1.7bn, if they are introduced in 2015. The company says around 80,000 members will be affected.

Coronavirus hit

The volatility of stock markets during the current pandemic has also increased pressures on pension schemes. The Pensions Regulator (TPR) has published new guidance setting out how employers can meet their automatic enrolment (AE) duties as they navigate the effects of the pandemic.

While the minimum correct contributions must be made on time, information published highlights flexibilities available to employers during this time.

Employers concerned they will struggle to make their contributions are urged to speak to their pension provider. TPR has written to providers asking them to be as flexible as possible when agreeing contribution payment dates.

The period in which schemes must report payment failures has been extended from 90 days to 150 days to give trustees and providers more time to work with employers to bring payments up to date.

Employers can also access information, which will be updated again in due course, about the government’s coronavirus job retention scheme which allows them to claim back minimum AE employer contributions for furloughed staff.

Drop triple lock

Meanwhile, the Social Market Foundation (SMF) has published research arguing the government should abandon its ‘triple lock’ promise regarding the state pension. This guarantees that the basic state pension will rise by the largest of 2.5%, the rate of inflation or average earnings growth.

The think tank is proposing the government move to a ‘double lock’, which drops the 2.5% promise. Its researchers calculate this could contribute £20bn to deficit reduction over the next five years. Pensions would still rise, but less quickly, reducing the fiscal burden on the working-age population.

The SMF argues this is needed in order to address what it terms ‘austerity round two’ as tax rises and spending cuts are needed to recover from the crisis.  It says the economic cost of tackling coronavirus will fall heavily on those of working age especially in terms of redundancies and lost income. Public sector net borrowing could rise above £200bn per year – higher than that seen in the financial crisis.

Unlike ‘austerity round one’, where the working age population bore the brunt of cuts in spending, especially via the welfare budget, the SMF says the fiscal costs of this crisis should be spread across all age groups, particularly given the current lockdown is aimed  at saving  the  lives of those at greatest risk, a group that is largely (but not exclusively) made up of older people.

Social Market Foundation report, Intergenerational fairness in the coronavirus economy

By Pat Sweet

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