Incoming RPI
changes could alter pension funding positions

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LCP’s second annual corporate sponsor report, released today, looks at how a new funding code and increased powers of the Regulator will affect corporate sponsors and scheme members alike.

The ONS has now confirmed its intention to reform RPI and replace it with the formulae underlying CPIH inflation, from 2030 at the latest. Even though this may not happen until 2030, it has vast consequences (potentially good news for some, bad news for others) which affect decisions being made now by pension sponsors and trustees.

LCP urges all sponsors to consider this issue carefully, but particularly if they are involved in any significant pensions action – for example, buying or selling of index-linked gilts or similar swaps, buy-ins and buy-outs, changing the index used for pension increases, transfer value or pension increase exchange (PIE) exercises, and long-term journey planning.

CPIH is expected to be around 1% pa less than current RPI, which is a big difference. This means that DB scheme members with RPI-linked increases will expect to get lower pensions from 2030 that they otherwise would have had. While a net financial gain is expected if the scheme increases are mainly RPI-linked and this is only partially hedged, schemes are likely to suffer a net financial loss if they are mainly CPI-linked and RPI instruments are in place to hedge this.

Actuarial valuations, company accounting, and long-term funding targets will all be impacted, while buy-in and buy-out insurers and consolidators may eventually charge less to take on RPI-linked benefits.

Year-end accounting assumptions for RPI and CPI must be set consistently to avoid unwanted volatility, and sponsors with upcoming year-ends need to address this now.

Other key challenges for corporate sponsors that the report explores include:

  • Following publication of the draft Pensions Bill in 2019, the Pensions Regulator is expected to gain significant new and far-reaching powers to tackle corporate misbehaviour, which could ultimately result in jail sentences for company directors of up to 7 years and very large personal fines.
  • Ensuring members receive their benefits without compromising shareholder value remains a significant challenge for corporate sponsors. The regulatory direction of travel is putting more pressure on the use of corporate resources, which the Regulator acknowledged in its comments about the potential use of contingent assets to enhance schemes’ recovery plans and strengthen short term security.
  • The DWP’s new DB funding legislation and guidance are due to be consulted on imminently. Despite sponsors being in limbo while the consultation processes play out, there is expected to be a fast-track route to compliance and an alternative bespoke approach which would be subject to greater regulatory scrutiny. Sponsors and trustees should be on the front foot, with a long term funding target mindset, and consider contingent funding solutions to avoid excessive cash funding.
  • In September 2019, corporate bond yields hit a record low of well below 2% pa – even lower than the previous all-time record in the aftermath of the Brexit referendum in 2016. For a company with a typical DB scheme this will cause a c.20% increase (over the year to date) in accounting liabilities before allowing for any mitigation from the assets.
  • LCP’s Spring 2019 Accounting for Pensions Report described the challenges for company directors in setting an appropriate set of longevity assumptions in light of the judgements required and the large number of separate longevity parameters that have to be decided upon.
  • GMP equalisation is also squarely on the agenda. Depending on progress made to date and the scheme’s specific circumstances, auditors could expect a possible recalibration of the balance sheet reserve at this year-end (for example if there is new data, or significant new analysis) to account for equalisation. For some there is still a risk that any recalibration will cause a new hit to profits.
  • Full scheme buy-ins and buy-outs are now becoming much more common than in the past. Each scheme is different, but this is an issue for companies to consider, regardless of where they currently stand in terms of their de-risking journey.
  • The International Accounting Standards Board is still considering changes to IFRIC14 which could bring significant extra liabilities onto the balance sheets of UK companies. The combined impact on the FTSE 100 could be £100bn, so this is not insignificant.
  • Recent IAS19 changes affect how companies account for special events (such as a change in benefits, redundancy exercise or M&A activity). These new rules can make the cost of events such as benefit changes more complex to calculate and harder to predict.
  • The IASB is using IAS19 as an early test of its wider Disclosure Initiative (as well as IFRS13 which deals with fair value of assets). This may lead in time to additional disclosure requirements, further increasing the length of a typical pensions disclosure.

Phil Cuddeford, partner and Head of Corporate Consulting at LCP, comments: “Regulations are changing quickly and corporate sponsors need to take advantage of the latest thinking to ensure they comply in a way that protects member benefits and shareholder value.”

“Markets are also changing rapidly and the RPI reforms will introduce big risks and opportunities. With a potential change to the funding position of +/-10%, the change will be huge good news for some and huge bad news for others. Regardless of the impact for each scheme, sponsors who engage now will be best-insulated from future shock.”

“As year-end approaches, it is important that sponsors keep in mind the upcoming inflationary changes. The switch may be some way off, but, given that we know it is coming, it would be foolish not to factor this into any decisions being taken now.”

A changing landscape

A changing landscape

for corporate sponsors

We address the key challenge for corporate sponsors: how do we ensure members get their benefits without compromising shareholder value?

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