What do the changes to RPI mean?

The UK Government has confirmed that changes to RPI will go ahead from 2030, and that they will not be providing compensation to holders of index-linked gilts.

Here are eight things that I think this means for UK pension schemes:

1. This is not a surprising outcome, given the well-publicised shortcomings of RPI and the pressure on Government finances from Covid-19 and Brexit.
2. The change was widely expected, and largely priced in by markets. Market reaction to the announcement has (so far) been relatively muted, with a shift in implied inflation between the 5-year and 10-year points suggesting markets saw some possibility the change would happen before 2030.
3. Because the change won't happen until 2030, we still have nearly ten years on the current measure of RPI. Ten years is a long time, and many things can change in that period. Between now and then, RPI needs to get proper care and maintenance. Pension scheme sponsors and trustees will still need to think about what is the right measure of inflation for the next ten years.
4. Relative to the old definition of RPI, the changes will reduce future returns for holders of index-linked gilts (mostly pension schemes and insurers); however, it will also reduce some of the long-standing problems in managing risks associated with CPI-linked benefits. Pension schemes and insurers should think about whether their investment and hedging strategies are efficient given the new definition of RPI.
5. The new definition of RPI will reduce the value of future payments for pension scheme members with RPI-linked benefits. There may be pressure on sponsors and trustees to soften the blow by giving additional pension increases over and above the new definition of RPI; however, this may not be as straightforward a decision as first appears. Sponsors will need to balance the needs of their pension scheme members with those of their current employees, and with the need to maintain the ongoing health of the business in current economic headwinds. Any decisions need to be taken in light of the strength of the business.
6. Some pension scheme sponsors and trustees will see their financial position improve (e.g. those providing RPI-linked benefits who have low levels of inflation hedging), while others will see their financial position worsen (e.g. those providing CPI-linked benefits who have high levels of RPI-based inflation hedging). For many, the effect on the overall financial position may be limited.
7. Some trustees and sponsors will see this as finally resolving the “rules lottery” whereby drafting choices made many years ago (in some cases before CPI was introduced) have bound their hands on how to measure inflation. Others have made conscious choices to use the RPI in spite of (or perhaps because of) its difference from CPI – these choices, and the expectations that members have as a consequence, will be key factors in how best to respond.
8. Sponsors, trustees and members looking at transfer values, looking at pension increase exchange, or looking at how they equalise benefits for the impact of GMPs will need to think carefully about what the change in RPI means for the financial outcomes, and risks, of the decisions they take.