RPI reform – will the views of various stakeholders be fairly represented?

Today, the Chancellor and the UK Statistics Authority (UKSA) launched consultations on the future of RPI. As previously indicated, the Chancellor is mainly consulting on when (not if) RPI is changed to CPIH. UKSA is consulting on technical aspects of transitioning the RPI index.

In this blog I discuss the question of compensation, likely timing of RPI reform, and actions that investors can take now.

Will investors receive compensation, and should they?

The consultations make no mention of potential compensation for holders of index-linked gilts. This will disappoint some investors, in particular:

• CPI-linked pension schemes – RPI reform is likely to be bad news, if index-linked gilts fall in value (whilst CPI-linked liabilities remain unchanged).
• Anyone who bought an index-linked gilt (or RPI-linked annuity) since January 2013, when the Office for National Statistics recommended “the formulae used at the elementary aggregate level in the RPI should remain unchanged”.

But at the same time, RPI is a flawed measure of inflation and the UKSA has a statutory duty to produce good statistics.

Let’s think about what compensation might look like. One potential approach is to change RPI to CPIH and add a fixed additional margin (eg 0.8% pa) to reflect the expected difference between the two. This would (theoretically) correct the underlying statistical issues with RPI and compensate investors for the change.

But whilst this would (greatly) reward index-linked gilt holders, it would be detrimental to many others:

• Why should RPI-linked pension schemes be forced to pay above inflationary increases?
• And why should businesses sponsoring pension schemes continue to pay for those higher increases?
• Why should taxpayers pay artificially high increases on the UK’s debt?
• Why should commuters (continue to) pay excessive increases on their rail fares?
• Why should graduates pay higher student debt repayments?

The list probably goes on.

Of course, there is also the very real issue of the impact on scheme members’ pension increases. In short, many pension increases are likely to be lower than they otherwise would have been. But, in the context of the UK as a whole, these pensioners are likely still to be better off than many other stakeholders on this matter.

It is worth remembering that even without compensation, index-linked gilt holders and pensioners will continue to receive higher increases until any change is made, perhaps out to 2030.

So, on balance, I believe that it was appropriate for the Chancellor to not include any questions on compensation in this consultation. Although I recognise that some investors may put forward a case for the opposite view.

Best guess at timing?

The Chancellor has the power to veto the proposed changes to RPI prior to 2030, at which point at which point it is expected to happen regardless. Indeed, the Chancellor is seeking views on whether the proposed changes “should be made for a date other than 2030”, which could imply the “default position” is to delay changes as far as possible.

As with the question on compensation discussed above, I believe that there are two camps here:

1. Asset owners will likely vote strongly for RPI to be left unchanged for as long as possible, ie more money rather than less money (thank you kindly).
2. Those listed above that stand to benefit from a lower RPI will likely support change happening as soon as possible.

I am certain that asset owners will lobby effectively in their interests. A previous consultation in 2012/13 on this matter resulted in a strong consensus to not reduce the value of index-linked gilts. However, responders were almost entirely the owners of those gilts.

But I am concerned that the second camp above, those who stand to benefit from a sooner change, may be less engaged with the consultation and ultimately less effective in ensuring that the Chancellor acknowledges their perspective.

The realist in me expects the change to be implemented from 2030, as previous experience tells me that the Chancellor will receive far more pressure from asset owners than the wider stakeholders. But I do hope that we see significant wider engagement on this issue, and that the Chancellor receives a balance of views in response to his consultation.

I also wouldn’t be surprised if compensation arguments rumble on and legal cases are brought forward about the post-2030 position in due course.

So, what can investors do?

The answer depends on how much of RPI reform you think is already in the price of index-linked gilts.

• If you think that RPI reform with “no compensation” is largely priced in, then it might be time to buy some index-linked gilts. They may now be a better investment, hedging both RPI-linked and CPI-linked liabilities. Plus, you never know, there just may be some compensation down the line.
• If you think that RPI reform with “no compensation” is likely to happen, but that the scenario isn’t sufficiently priced in to current markets (or that markets have underestimated the chance of it happening before 2030), then you may take a different approach. There may still be opportunities in the short term to sell index-linked gilts, switch into shorter-dated index-linked gilts or access CPI markets (including insurance products) to protect against future asset losses.

As ever, each investor will be different and decisions on what to do will depend heavily on specific inflation linkages and wider circumstances.

Whatever the position of your investments, any pension scheme members you represent, and your personal view, I would urge everyone reading this to engage with the consultations and consider potential investment actions.

The consultation and further detail can be found here .The deadline for responses is the 22nd April.