Since 2010, the government has dropped the retail price index (RPI) as an official inflation measure, switching to the consumer price index (CPI).
DB schemes can change to the CPI, as long as its own rules don’t specifically mention RPI. This was the case of BT, which saw the High Court recently denying its request to change the inflation measure.
DB schemes members’ benefits would decrease by £80-90bn if their pension schemes were allowed to switch from the outdated RPI, according to data from the Department for Work and Pensions (DWP).
Sarah Brown, principal of transaction services, at Xafinity Punter Southall, said: “It is almost a bit of a lottery based on how the scheme rules were drafted - some of them went straight to CPI while others are locked-in to RPI and can't change it without more legislation from the government.
“Moving from RPI to CPI could actually reduce the scheme total liabilities by around 10-15 per cent. In a context of £500m scheme, that's a £50-75m saving, so that is why is such a big deal for schemes.”
Ms Brown argued that the government could come up with a middle ground solution for distressed schemes, “when it looks like they might end up in the PPF and members will have a benefit cut anyway”.
She said: “I think that might be the first focus for the government, actually looking at where there is a genuine issue of affordability, and if they could be allowed to move to CPI - but that is very difficult to access.”
Sir Steve Webb, director of policy at Royal London and former pensions minister, said the government will have to mention this topic in the DB white paper, due to be published in the spring.
However, he doesn’t believe that there will be any changes on this.
He said: “It would be controversial and brave [to propose any solution]. It's possible in extremis.
“If it is going to make a difference, it is going to affect big schemes, and would mean a lot of people getting smaller pensions, which is controversial.”
A spokesperson at the Department for Work and Pensions declined to comment on this matter, saying that the government doesn’t “speculate on the content of forthcoming policy papers”.
The issue, which has been debate almost during a decade in the pensions industry, is making a comeback, with people such as the Bank of England governor Mark Carney arguing that CPI should be only one measure of inflation used by the government.
Ms Brown added: “There is a rising tide of people talking about this issue; the fact that we have people like Mark Carney talking about it has put it back into focus in the agenda.
“There are various forces at work, and one of them is if there is political will and political time to unravel all of this.”
And even in the cases where pension schemes are allowed to change the inflation measure, a lot of them won’t do it, argued Rosalind Connor, partner at ARC Pensions law firm.
She said: “The British Airways case last year was all about a fight between the trustees and the employer about whether members should be compensated when the scheme rules automatically moved from RPI to CPI.”
RPI rose by 3.6 per cent in the second quarter of 2017 and is expected to be hovering around the 3 per cent inflation mark by 2020, according to the Office for Budget Responsibility.
CPI inflation, in contrast, was 2.7 per cent in the second quarter of 2017 and is expected to be levelling out at the 2 per cent mark by 2020.
Pension schemes use inflation for two measurements: revaluation, the period from when the member leaves the scheme up to retirement; and indexation, which measures how much a pension goes up each year in retirement.
Sir Steve said: “Put them together, you can be talking 40 years. And if you get 40 years at a higher percentage than a lower, that might be a very material difference for a lot of pension schemes.”
Paul Hamilton, partner at Barnett Waddingham, explained that the main reasons schemes are in deficit is because of increased life expectancy, and low expected investment returns.
He said: “Both of these also make increases even more expensive, so schemes struggling to fund their benefits would often prefer to use the lower inflation measure – CPI, and for those unable to, it can seem unfair that other schemes can, just because their rules were worded slightly differently.”
According to William Burrows, retirement director at Better Retirement, the impact of changing the inflation measurement will depend on the size of the pensions.
He said: “For small pots the difference is small but for bigger pots it can make a big difference.”
maria.espadinha@ft.com
