RPI reform: The thin edge of the wedge

Recent updates from the UK Statistics Authority and Chancellor of the Exchequer, Sajid Javid, suggest an increased likelihood that the RPI (Retail Price Index) may be amended during the next 10 years to equal the CPIH, in our view. This could have material negative impacts for some pension schemes' funding levels and hedge ratios, especially for those hedging CPI-linked liabilities with RPI-linked assets.

Capital at risk. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

What’s next and what schemes can do

We believe there is a high likelihood that RPI will be amended during the next 10 years to equal the CPIH, based on what we currently know, although a strong reaction against this change from the pension and insurance industry could cause pause for thought. So far, the market has reacted to the recent updates by reducing long-term expectations for the difference between the RPI and CPI – the wedge – to persist. Over time, we expect this wedge to fall further, potentially to zero, if the market becomes increasingly confident that this change will eventually be implemented.

The next major updates are likely to come in early 2020 when a consultation is launched by the Treasury into the proposed RPI reforms. The impact of any change is likely to vary from scheme to scheme and is inherently complex based on the underlying liabilities of individual schemes. Schemes should ensure they clearly understand their full underlying liabilities and how they are hedging these before the next developments in RPI reform – and they may wish to consider the use of CPI-linked instruments to hedge their liabilities.

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