Scrapping the retail price index (RPI) as a measure of inflation, as currently being debated, would leave pensioners of defined benefit (DB) schemes £12,000 worse off, according to a trade union.
In its submission to the Lords Economic Affairs Committee inquiry about the inflation measures used in the UK, Unison said pensioners would be affected, alongside workers, which would see approximately £350 stripped from their annual income if their pay rose in line with the consumer price index (CPI) rather than RPI.
The Department for Work and Pensions (DWP) has previously stated final salary members’ benefits would decrease by £80-90bn if their pension schemes were allowed to switch from the outdated RPI.
RPI generally runs at about 1 percentage point higher than CPI. RPI is currently 3.5 per cent, compared with CPI of 2.7 per cent.
In 2010 the government dropped RPI as an official inflation measure, switching to the CPI.
Pension schemes can link increases to their employees' pensions - and therefore the employers' liabilities - to CPI, as long as their own rules don’t specifically mention RPI.
But while public sector DB schemes have shifted to CPI uprating, Unison quoted government sources which suggested that three quarters of private sector schemes were still pegged to RPI.
There has been a long-term debate in the DB pension sector about switching inflation measures, with the High Court recently denying BT’s request for this change.
The discussion has been making a comeback, with people such as Bank of England governor Mark Carney arguing that CPI should be the only measure of inflation used by the government, which still uses RPI in some cases, such as rail fares.
According to the Institute and Faculty of Actuaries (IFoA), if a scheme was to change inflation indexes, a 65-year-old man who had been expecting pension increases in line with RPI, could expect to receive aggregate lifetime pension payments about 10 – 15 per cent lower.
In its own submission to the Lords inquiry, the IFoA suggested that a possible solution to the problem would be to continue to calculate RPI but bring it in line with CPI - or CPIH, which includes housing costs.
A side effect of this, however, would be that "many schemes which have criteria for changing indexation based on RPI ceasing to be published may be trapped in the new calculation, rather than being enabled to consider what is most suitable for them," the IFoA warned.
Paul Gibson, managing director of Granite Financial Planning, said he has always viewed CPI "as a political rate of inflation designed to cut government costs".
He said: "RPI is generally higher and if you are a member of a DB pension scheme you would prefer benefits to be linked to RPI. Conversely if you are the finance director of the scheme CPI would be your preferred option.
"I think schemes should be forced to maintain the RPI linking unless there was an overwhelming reason to change, e.g. the financial stability of the scheme."