The UK’s recent announcement that it will use a new method for measuring inflation will have “vast consequences” for pension plan sponsors and trustees, even though the change might not occur until 2030, said investment consultant Lane Clark & Peacock (LCP).
In September, the UK Statistics Authority (UKSA) announced that it would align the Retail Prices Index (RPI) measure of inflation with the consumer prices index including owner occupiers’ housing costs (CPIH). The UK has been using RPI to measure inflation since 1947, but in recent years this has been deemed an inferior determination of inflation compared with CPIH, which was adopted as the government’s lead inflation indicator in 2017.
CPIH is expected to be around 1% less per year than current RPI, which LCP said is a big difference, and means that defined benefit plan members with RPI-linked increases can expect to receive lower pensions from 2030, or possibly earlier, than they otherwise would have. LCP said actuarial valuations, company accounting, and long-term funding targets will be impacted, while buy-in and buy-out insurers and consolidators may eventually charge less to take on RPI-linked benefits.
“The change will be huge good news for some and huge bad news for others,” Phil Cuddeford, LCP’s head of corporate consulting, said in a statement. “Regardless of the impact for each scheme, sponsors who engage now will be best-insulated from future shock.”
LCP is urging all plan sponsors to consider the issue carefully, particularly if they are involved in any significant pensions action such as buying or selling of index-linked gilts or similar swaps, buy-ins and buy-outs, changing the index used for pension increases, transfer value or pension increase exchange (PIE) exercises, and long-term journey planning.
The firm also said that year-end accounting assumptions for RPI and CPI must be set consistently to avoid unwanted volatility, and sponsors with upcoming year-ends need to address this immediately.
“As year-end approaches, it is important that sponsors keep in mind the upcoming inflationary changes,” said Cuddeford. “The switch may be some way off, but, given that we know it is coming, it would be foolish not to factor this into any decisions being taken now.”
LCP noted other key challenges for corporate sponsors:
- Ensuring members receive their benefits without compromising shareholder value remains a significant challenge for corporate sponsors.
- In September, corporate bond yields hit a record low of well below 2% – even lower than the previous all-time record in the aftermath of the Brexit referendum in 2016. For a company with a typical defined benefit plan, this will cause an approximately 20% increase in accounting liabilities.
- Buy-ins and buy-outs are now becoming much more common than in the past. Each scheme is different, but this is an issue for companies to consider.
- The International Accounting Standards Board is still considering changes that could bring significant extra liabilities onto the balance sheets of UK companies.
- Recent IAS19 changes affect how companies account for special events, such as a change in benefits, redundancy exercise or M&A activity. The new rules can make the cost of events such as benefit changes more complex to calculate and harder to predict.