Inflation is usually measured by the Retail Price Index (RPI) or Consumer Price Index (CPI) with the two measures usually producing different results. These measures are used to determine how changes are made to certain pensions, mortgages and other financial assets.
While the government is yet to officially announce anything, they have expressed a desire to reform RPI calculations.
This will have far reaching repercussions and the Association of British Insurers (ABI) has warned that the government’s proposals could cost the UK £122billion if the plans are implemented in 2025, which is the earliest that any changes could be made according to the government.
ABI explained that it would affect savers, especially those with defined benefit pensions, as well as companies that invest in government debt linked to inflation (known as index-linked gilts).
As the organisation detailed: “The Government and the UK Statistics Authority are consulting on reforms to align RPI to the historically lower Consumer Prices Index (including owner occupiers’ housing costs, CPIH).
In its official response, the ABI called for the latest possible implementation date to reduce the impact on savers.
Additionally, they recommended that compensation for affected savers should be considered given how dramatic the impacts could be.
ABI warn that those with life insurance policies, pension’s policyholders and defined benefit pension scheme members are likely to see the worst of the outcomes.
Hugh Savill, a Director of Conduct and Regulation at the ABI, commented on the consultation and potential reforms: “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.”
This sentiment is shared by many within the industry, with Jos Vermeulen, the head of solution design at Insight Investment, noting that it is an issue to address now and not leave for the coming years: “We believe that a fair and equitable outcome can be achieved if RPI is aligned with CPIH plus an appropriate margin to ensure that there are no resultant losers.
“Unless this or an alternative solution is adopted, pension schemes and other holders of index-linked gilts could be facing a transfer of wealth to the UK government of up to £130bn; with the impact of Covid-19 making the pain £10bn more today than it was in March.
“The impact of reform will be felt immediately by pension schemes and individuals – this is not a problem for 2025 or 2030, but for now. For pension schemes, the resulting hit to their funding levels may only be compounding problems for companies which are already struggling with deficits in light of the Covid-19 crisis, making it even harder to plug these gaps.
“For individuals, the impact on their savings will also be immediate.
“Our calculations have shown that the current proposal could see members losing up to 20 percent of their expected income. This will have a significant effect, not only for those entering retirement but also any members who may be looking to enter pension transfer deals and suddenly find their hard-earned pots are worth significantly less.
“Through our own technical response to the consultation, we have urged the UK government and UKSA to give careful consideration to the broader economic consequences of reform before making their final decision. We can now only hope they listen.”
Published at Thu, 20 Aug 2020 23:01:00 +0000