Cambridge University and British Telecom (BT) are the first two institutions to issue index-linked bonds using the consumer price index (CPI), fueling a long-standing debate about inflation measures used by pension schemes.
DB pension schemes are set up under trust by employers to provide for pension obligations to their employees, which are long‐term and inflation‐linked.
The defined benefit (DB) pension sector has been discussing switching inflation measures since the government dropped the retail price index (RPI) as an official inflation measure in 2010.
RPI generally runs about 1 percentage point higher than CPI, and RPI is currently 3.3 per cent compared CPI of 2.3 per cent.
Pension schemes can change to linking increases to their employees' pensions - and therefore the employers' liabilities - to CPI, as long as its own rules don’t specifically mention RPI.
Final salary members’ benefits would decrease by £80-90bn if their pension schemes were allowed to switch from the outdated RPI, according to data from the Department for Work and Pensions (DWP).
As investors, pensions schemes have urged the Debt Management Office (DMO) – an executive body of the UK Treasury that manages all Gilt issuance - to consider using CPI rather than RPI for its inflation-linked debt, but the entity hasn’t done so.
DB pension schemes invest heavily in government bonds, or gilts.
Last week (20 June), Cambridge University became the first institution to issue an index-linked bond using the new inflation measure.
According to FTAdviser’s sister newspaper Financial Times, the university sold £300m of 50-year index-linked bonds using CPI, alongside £300m of 60-year conventional debt.
The following day (21 June), BT announced it would issue £2bn of long dated sterling denominated bonds to be held by the BT Pension Scheme (BTPS), its final salary plan.
Half of these were issued using CPI, the company stated in a market update.
BT will use the proceeds from the issuance of these bonds to make pension deficit contributions under the recovery plan agreed between BT and the BTPS as part of the 2017 funding valuation agreement.
The telecom company has been trying to switch from RPI to CPI for pension increases to its members, but the High Court has denied such move.
Ian Neale, director at pensions technical specialist Aries Insight, told FTAdviser the issuance of the first CPI-linked bond “should be a spur to action from the government, if not the DMO, which remains obdurate for now”.
He said: “The fact is that a significant portion of current DB liabilities carry CPI-indexation, and pension schemes which have adopted a derisking strategy are keen to buy matching, necessarily long-dated, gilts.
“The DMO has totally failed to respond to the demand: there are no CPI-linked gilts.”
The DMO consulted on issuing this type of debt in 2011. At the time, the government concluded that issuing CPI-linked gilts in the near-term would be unlikely to be cost-effective. It would involve a number of risks, although it said that it was possible that this could change over time.