Government proposals to scrap the retail price index will hit pension savers to the tune of £122bn, the Association of British Insurers has warned.
The association warned the government's plans to replace the RPI with the consumer prices index including housing costs will hit people with defined benefits pensions particularly hard as they face significantly reduced returns.
Companies that invest in government debt linked to inflation - known as index-linked gilts - will also be affected, the ABI warned.
RPI generally runs at about 1 percentage point higher than CPI and is currently 1.6 per cent, compared to a CPI of 1 per cent.
The ABI estimates implementing the changes by 2025 could leave those affected £122bn worse off and pushing it back to 2030 would reduce the cost to £96bn.
In its response to the government’s consultation, which closes today (August 21), the ABI called for the latest possible implementation date and recommended savers are compensated for their losses.
Hugh Savill, director of conduct and regulation at the ABI said: “It is widely accepted that the RPI model is less than perfect, but the proposal’s impact will be felt by policyholders and pension savers for decades.
“If the reforms go ahead, and given the impact for savers and the wider economy, it is vital the implementation date is later rather than sooner. Compensation by the government should also be seriously considered to avoid creating winners and losers.”
Tom Selby, senior analyst at AJ Bell, warned annuities could also be affected.
Mr Selby said: “The impact of such a move will be felt by a huge number of people in different ways. There are, for example, defined benefit schemes where scheme rules mandate members’ retirement incomes rise in line with RPI.
“If these contracts were ripped up and RPI replaced with CPIH – which tends to be lower – it would effectively represent a stealth cut to people’s hard-earned retirement pots. Any annuities linked to RPI would also be worth less if this link was downgraded to the CPIH inflation measure.
“Anyone invested in index-linked gilts - including individuals and pension funds - would also see the value of their holdings tumble if the government applied a blanket overnight switch from RPI to CPIH.”
He added: “The big question the government needs to answer is the extent to which it will mitigate any negative impact on people with pensions and investments explicitly linked to RPI.
“One option in this regard would be to maintain a notional RPI which these contracts could then adopt, although this might mean RPI remains part of the system for decades.”
The government’s consultation on RPI reform was extended by four months in April in light of the coronavirus crisis.
Originally, the consultation was due to close on April 22 with a government response due before the summer parliamentary recess but this is now expected to be in autumn.