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Switching UK pension indexation to CPI may add complexity, experts warn

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UK - Government plans to change the indexation of private sector defined benefit (DB) occupational pensions from Retail Price Inflation (RPI) to Consumer Price Inflation (CPI) in line with changes to public sector pensions could cause even more complexity to pensions.

In a written statement to Parliament yesterday, Steve Webb, the minister for pensions, said: "The government believes the CPI provides a more appropriate measure of pension recipients' inflation experiences and is also consistent with the measure of inflation used by the Bank of England.

"Therefore, it is right to use the same index in determining increases for all occupational pensions and payments made by the Pension Protection Fund and Financial Assistance Scheme."

He said using CPI would mean making some "small changes to primary legislation" to ensure it could be applied fully in every circumstance.

"We will bring these before Parliament at the earliest opportunity," he added.

However, Robin Simmons, partner at law firm Sacker & Partners, said scheme members could see their benefits lag the "real" increasing cost of living (RPI). 

And administrators could see further complexity added to the administration of members' benefits, just when there is pressure from the Pensions Regulator on administrators to improve member records.

Simmons said: "This impacts many areas for DB pension schemes - from administration, to funding, to investment.

"There are a number of important issues employers and trustees are going to have to work through this year now."

In particular, he highlighted the issue of amending scheme rules, as this will depend on the wording used by each scheme.

The law requires schemes to uprate benefits by the "percentage increase in the general level of prices in Great Britain".

The government makes an order stating what this increase is each year, and in the past it has always been RPI so some schemes have "hardcoded" the term RPI into their rules.

Simmons warned: "Lots of schemes will have written the increases into the rules as RPI, which is perfectly proper, as that is what has been understood as the increase in general level of prices.

"But you can't change that for past benefits, only for future benefits accruing past a point such as April next year."

Future benefits and the indexation of deferred pensions can be switched to CPI, but schemes will need to change the rules, and this will not affect past benefits unless the government allows a 'carve out' from section 67 of the Pensions Act 1995 that prohibits schemes from adverse changes to benefits without the members' consent.

Alternatively, some schemes may have stated increases will be in line with statutory requirements, or used the exact wording of the legislation, in which case they "may not have to do much at all, just take advantage of the changes", Simmons said.

Mike Smedley, pensions partner at KPMG, added: "We urge the government to make the legislation apply equally to all schemes and avoid a small-print lottery for schemes and their members depending on technicalities and details of the scheme's legal documents."

The change could also impact investment behaviour, as the switch to CPI is likely to reduce liabilities, with Hymans Robertson suggesting it could reduce the collective pension deficit of the FTSE 350 by £50bn (€60bn), providing the measure applies to pensions in payment.

Lower liabilities could increase the number of pension schemes looking to buyout liabilities, while those that have already de-risked through insurance products and swaps linked to inflation could find they are paying more for a product if the transaction is based on RPI.

The National Association of Pension Funds (NAPF) said the move would provide DB schemes with more flexibility and make it easier for companies to keep these arrangements open.

But Joanne Segars, chief executive of the NAPF, warned: "The detail needs to be right so the change can be applied smoothly and simply."

And Patrick Bloomfield, partner at Hymans Robertson, said moving from RPI to CPI would not be straightforward. 

"Pensions that have already built up are legally protected against being worsened, so it will be interesting to see how the government will overcome this hurdle," he said.

"We hope the implementation is workable and not overly complex. Otherwise, the potential savings will be eroded by yet more administrative cost."

Part of the rationale behind moving from RPI to CPI is that CPI does not include mortgage repayments so is more appropriate for pensioners.

However, Hargreaves Lansdown has pointed out that CPI also does not include council tax, which accounts for 7% of over 75s' expenditure compared with 3% for those under 50, according to the UN Office for National Statistics.

Laith Khalaf, pensions analyst at the company, said: "In truth, neither CPI nor RPI is a pinpoint measure of pensioner inflation, which is disproportionately affected by increases in food, energy bills and council tax.

"The change from RPI to CPI will also impinge on pre-retirees with preserved pensions, who do have exposure to mortgage interest costs."

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