Sorca Kelly-Scholte, JP Morgan Asset Management’s (JPMAM) EMEA head of pension solutions and advisory, discussed with editor Venilia Amorim how she thinks pension funds can plan for the road ahead, in light of the uncertainty over the future of RPI and whether or not it gets fully phased out.

Not only is the RPI written into many defined benefit (DB) trust deeds as the reference index for benefit adjustments, but the index is also used to adjust the coupon and principal payments on index-linked Gilts.

By JPMAM’s estimate, pension funds hold around two thirds of the total index-linked market. That means many funds stand to lose out financially if the RPI is aligned to the CPIH without compensation being offered to affected bondholders.

To assess the potential exposure of pension funds, Kelly-Scholte has looked at the extent to which RPI reform has already been priced into index-linked Gilts.

How could changes to price indices affect DB schemes?

Changes to price indices could affect both sides of the pension balance sheet.

On the asset side, a switch from RPI to CPIH would reduce future coupons and redemption payments on index-linked Gilts, as CPIH is on average expected to be about 1% per annum lower than RPI.

RPI swaps would be similarly affected. The same applies to any other asset with payments linked contractually to RPI, such as RPI-linked corporate bonds.

On the liability side, if the reference index for increasing pensions is currently RPI, the change to price indices will reduce future expected pension payments.

From the pension balance sheet perspective, this reduces liabilities, but of course from the individual member perspective it reduces future benefits.

The combined effect will vary, depending on their exposure on each side of the balance sheet.

 CPI Linked LiabilitiesRPI-Linked Liabilities

Matched with Index-Linked Gilts


No gain/loss


No gain/loss


What impact will the switch from RPI to CPIH have on the value of pension fund assets?

If no change to RPI were priced in, and assuming no compensation for current holders, index-linked Gilts could fall in value by the order of 20-22%.

As DB pension funds hold around a third of their assets in index-linked Gilts, this would mean a fall in the value of pension assets of around 6.5%-7.25%.

However, our analysis suggests that the change from RPI to CPI is already largely priced in – around 60-80%.

As such, from current conditions, we would expect a 4-6% fall in values, or £50-£60bn (€54.9-65.9bn), if RPI were to be fully aligned to CPI with no compensation.

Many schemes use RPI-linked assets as part of their LDI strategies and RPI-linked Gilts and inflation swaps to hedge inflation. What would be the alternative under a CPIH scenario?

The only instruments that hedge inflation and changes in expected levels of inflation are index-linked Gilts and inflation swaps.

To maintain the same level of hedging, pension funds would need to adjust the size and potentially the structure of their existing portfolio of index-linked Gilts and inflation swaps.

There is a small market in CPI swaps, where we have seen an uptick in activity recently, which suggests that some of this restructuring from may already be underway.

Sorca Kelly-Scholte, JP Morgan Asset Management

Sorca Kelly-Scholte, JP Morgan Asset Management

There are other ways to build in long-term inflation protection to portfolios, however, by adding more assets that have return streams linked to inflation – in particular assets such as property and infrastructure.

These assets may not be as immediately responsive to changing inflation expectations as index-linked Gilts, but can be a valuable source of protection against rising inflation in the long-term.

How can a change in index affect buy-out and buy-in markets?

Bulk annuity providers face exactly the same challenges as pension funds, in that they hold index-linked Gilts and inflation swaps that are primarily linked to RPI to hedge liabilities, and may need to adjust their hedges accordingly.

On the face of it, pension funds with liabilities linked to RPI may see the cost of insuring those liabilities fall.

However, annuity providers may have capacity constraints linked to their ability to source appropriate assets in which to invest.

It is notable that insurers have been increasing their allocations to real estate, and there is a live debate around how solvency II might be adjusted to permit more investment in real assets such as infrastructure.

What mitigating measures could be taken to reduce the impact on schemes’ asset values?

As mentioned previously, most of the proposed change in RPI has already been priced into markets, so the impact has already been suffered.

The best way to avoid further losses, if the change is made without any compensation, would be to sell current holdings.

But this removes the possibility of any gains should compensation be offered, or if the issue of RPI reform is deferred again.

Longer term, we believe that plans should look to build broader inflation-protection strategies, building out and globalising real estate asset allocations, and adding allocations to other real assets such as infrastructure.

To read the digital edition of IPE’s latest magazine click here.