RPI Rejig: Government Can Pay £40bn Compensation
There is a chance of a judicial challenge getting filed soon against the revision of the retail prices index. And it can cause the Government to pay compensation costs equal to the entire defense budget.
Analysts predict that if the Government loses, it may compel the Treasury to compensate holders of index-linked government bonds linked to the RPI for up to £40 billion.
To understand it better, let’s just learn a little about RPI and the recent changes proposed for it.
What is the Retail Price Index (RPI)?
It is one of the two primary consumer inflation indices issued by the UK’s Office for National Statistics. Although the U.K. does not view it as an official statistic, authorities still use it for some forms of cost growth.
The Retail Price Index (RPI) is a traditional measure of inflation. Besides, it is still in publication. The authorities still use it to determine the cost of living and wage growth. However, it is not regarded as the government’s official inflation rate. The Cost of Living Index was substantially replaced by the RPI when it was first calculated in June 1947. Moreover, it once served as the primary official indicator of inflation. However, in reality, the consumer prices index (CPI) now largely fulfills that function.
What are the major changes proposed for RPI?
The UK Statistics Authority has hinted that it plans to modify RPI in order to bring it into line with CPIH. Such a move might have significant effects on UK pension plans. And this could include both index-linked gilt holders and payers of RPI-linked pensions.
The UK Statistics Authority (UKSA) has been questioning for some time whether the RPI is a reliable indicator of inflation. Meanwhile, we have the Consumer Prices Index (CPI), an alternative inflation indicator. It is often regarded as a more accurate indicator and authorities use it for many things. It includes the Bank of England’s inflation objective.
The UKSA said on September 4, 2019, that it would modify the RPI to align it with the CPI. Moreover, it’d take owner-occupier housing expenses into account (CPIH).
So, what’s the judicial review for?
BT, Marks & Spencer, and Ford UK pension schemes are challenging chancellor Rishi Sunak in a hearing at the Royal Courts of Justice presided over by Mr. Justice Holgate.
At the request of the UK Statistics Authority, Sunak announced in 2020 that he would amend the definition of RPI. The intention was to make it similar to CPIH with the change taking effect in 2030.
As we know, due to a methodological fault in its calculation, RPI has long been rejected as a gauge of the cost of living. Moreover, it typically differs from CPIH by 0.8 to 1 % point annually.
After the announcement of changes, inflation-protected bondholders, or “linkers,” argue that this is unimportant. Moreover, when they purchased the bonds with the interest rate based on RPI, they had a reasonable assumption that the conditions would not alter.
We didn’t expect that the challenge would succeed. However, if it does, it might increase the cost of government borrowing according to Ian Mills. He’s a partner at actuaries Barnett Waddingham. Moreover, while increasing the cost of government borrowing, it could also destabilize the gilts market. Additionally, it can give a heavy blow to the holders of linkers and those whose pension rises are linked to the RPI.
How much would be the compensation?
The compensation number might be bigger than the UK’s annual military budget. Yet, if compensation is given, this would greatly increase pension plan funding levels at a tremendous cost to the public.
Many linkers are extremely dated and won’t mature for decades. Therefore, the proposed adjustment has already significantly reduced their worth. The entire cost to investors, according to Insight Investment, might reach £100 billion. Moreover, around £400 billion in linkers are still unpaid.
The BT scheme, which has 275,000 members, estimated earlier that the formula change would result in a loss of £1 billion.
Rail tickets and interest on student loans could suffer if the challenge is successful. Both of these are based on RPI and, and so under Sunak’s current plans, should climb less after 2030.
We can expect the case to last for two days. However, the judgment won’t come until September.
What does the Treasury say?
According to the Treasury, there is no justification for the compensation as linkers would still be connected to “RPI.” Though that will be a little different.
Depending on the pension plan, a successful challenge would have different effects. However, on the asset side, some have substantially greater stocks of linkers than others. Some raise pensions and preserve pensions yearly under the RPI. Meanwhile, others do it in accordance with the CPI.
According to Jos Vermeulen of Insight Investment, a significant gilt investor, “£100 billion is on the line for pensioners.” He says that the idea would result in decreased benefits for thousands of pension scheme participants. Besides, women would suffer more from the decreased inflation protection since they would live longer and hence be at a financial disadvantage.
