"If the court’s decision leaves any doubt then this could affect the smooth operation of the market, potentially pushing up the government’s cost of borrowing."
The UK Statistics Authority announced in November 2020 changes to RPI; to change the longstanding method of calculating inflation to align with the CPIH inflation index, which are to apply from 2030. Owing to the different calculation methodologies, the longstanding RPI method is expected to result in higher inflation figures than the CPIH method. Last month, the rate of RPI inflation was 11.1% and the CPIH rate was 7.8%. This change arguably worsened the funding positions of many well-run pension schemes, and resulted in lower incomes for those on RPI-linked pensions.
The legal case launched this morning challenges whether the UKSA and the Chancellor have the power to change RPI in this way and whether they properly applied their powers. This challenge could reverse the decision to change the RPI calculation, and could have significant financial ramifications across the economy.
What would happen if the case is successful?
There is over £400bn of RPI-linked government debt outstanding. Holders of this debt would stand to benefit if the decision is reversed, or compensation is paid.
If the judicial review is successful then there could be a range of outcomes:
- The UKSA and the Chancellor could be asked to consider the decision again, potentially leading to a similar result.
- The changes made to RPI might have to be reversed, meaning:
A 65-year-old retiring now with an RPI-linked pension of £5,000pa would ultimately gain ca. £15,000 over their lifetime.
A 55-year-old retiring in 10 years’ time with an RPI-linked pension of £5,000pa would gain even more – ca. £32,000 over their lifetime.
- Or the UKSA presses on with the changes to the RPI, but the Chancellor might be forced to pay compensation of £40billion to holders of RPI-linked bonds.
Ian Mills, partner at Barnett Waddingham, commented: “The changes to RPI announced in 2020 were not universally popular but the market expects them to go through in 2030 and has been operating under that assumption since then. If the court’s decision leaves any doubt then this could affect the smooth operation of the market, potentially pushing up the government’s cost of borrowing.
“The court case being heard on 22 June is a late attempt to reverse the referee’s decision; it is not expected to succeed.
“If the lawyers do succeed, then this could lead to a boost to some pensioners, with the cost being picked up by pension schemes. Or it could mean payments to bondholders, but at the expense of the taxpayer.
“If compensation is paid then this would significantly improve pension scheme funding levels, but at a colossal cost to the taxpayer - the compensation figure could be greater than the UK’s annual defence budget.
“It’s likely that the sharp rise in energy prices will mean that, whichever method is used, pensioners are likely to find their income isn’t keeping pace with their outgoings. So with inflation at multi-decade highs what seems like statistical sleight of hand will be of little consolation to pensioners who are currently struggling to make ends meet.
“Many pension schemes would benefit from a reversal of the decision – they would expect their inflation-linked gilt holdings to appreciate whilst their CPI-linked pensions would be unaffected. This could meaningfully improve funding positions.
“However, some other schemes (those with RPI-linked pensions and who have decided not to hedge their inflation risks) could suffer further. Rising inflation will already have damaged the funding position of these schemes, and reversing the decision would add further pressure on their funding positions.”