Paul Johnson’s Review of UK consumer price indices [1] has been published by the UK Statistics Authority today. Towers Watson says that, if his recommendations are accepted, this will affect how pensions are uprated and the investment options that schemes have.

Pensions currently linked to CPI*

The Johnson Review says that CPIH** should become the UK’s main measure of inflation and should “be the starting point for uprating wages, benefits and other payments”.

Jonathan Gardner, senior economist at Towers Watson, said: “If this recommendation is accepted, CPIH could well be used for uprating defined benefit pensions currently linked to CPI, as well as being used in the State Pension ‘triple lock’.  However, Paul Johnson also recommended that inflation indices for different types of household, such as pensioners, should be published annually. There might be pressure on the Government to use a pensioner inflation index instead, particularly when this is higher.

“Ultimately, moving to CPIH might not make any difference to the pension increases that schemes have to award. If the Bank of England successfully targeted 2% CPIH inflation instead of 2% CPI inflation, the inflation number should be the same even if it is measuring something else.  Pension liabilities would only change if the way pensions are uprated changes while the Bank’s target – and likelihood of meeting it – does not.  CPIH inflation has been identical to CPI inflation in recent months, having been slightly lower in the previous three years, but this relationship could change in future.”

Pensions currently linked to RPI***

GBP CoinsThe Johnson Review says that the ONS should “restate that the RPI is a flawed statistical measure of inflation…whose use should be discontinued for all purposes unless there are contractual commitments at stake.”  It calls for the “eventual discontinuation” of RPI but says that this must be “carefully managed over an extended period” because there are many long-term RPI-linked contracts.

Jonathan Gardner said: “In some cases, pension scheme rules may allow some leeway as to which inflation measure is used, but many are clear that benefits are linked to RPI.  It’s unclear how ‘extended’ the period for phasing out RPI might be: the authorities might not wait until the last RPI-linked pension has been paid out before bringing the curtain down.

"Even over the next few years, the Review could have some impact on pension increases that remain RPI-linked: it recommends that improvements to how CPI is compiled should not be carried across to RPI.

“Conceivably, some schemes’ rules might allow them to shift from RPI to RPIJ***, but not to CPI or CPIH. As Johnson calls for RPIJ to be discontinued, that might prove an unsustainable option.”

CPI/CPIH-linked gilts?

The Review says that “government should move away from selling gilts linked to the RPI, subject to consultation and assurance about the demand for CPI or CPIH linked gilts”.

Jonathan Gardner said: “Schemes wanting to hedge CPI (or CPIH) linked liabilities would welcome a decision to start issuing this sort of gilt in future. However, demand would depend on clarity that statutory pension increases would continue to be based on the main national inflation measure rather than a pensioner index.

“The Debt Management Office rejected the idea of issuing CPI-linked gilts in 2011, fearing that it would fragment the gilt market, but said this would be kept under review.


*The Consumer Price Index (CPI) is the UK’s version of the Harmonised Index of Consumer Prices, which is constructed according to European standards. CPI does not presently include owner-occupiers’ housing costs.

**CPIH incorporates owner-occupiers’ housing costs by estimating the rents that households would have to pay to live in similar properties.

***The Retail Price Index (RPI) is a UK measure of inflation that dates back to 1947. RPIJ is a recently-introduced variant to RPI; it replaces a formula that does not meet international standards with a formula used in CPI.

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