Inflation measure downgrade casts further doubt on pension increases

CPIH’s loss of national statistic status means some schemes may need to look once again at their pension increase rules.

The UK Statistics Authority has today suspended the National Statistic status of the 'CPIH' inflation measure.

The announcement comes just over a year after CPIH was introduced in March 2013.  The wording of many pension schemes’ rules allows them a degree of flexibility in the choice of inflation measure to use for pension increases.  Employers welcomed the CPIH measure as a cost-saving alternative to the traditional measures and pointed to CPIH’s status as a National Statistic to help justify using it, after RPI’s own National Statistic status was revoked in 2013.

Schemes which moved to using CPIH to apply pension increases may now wish to reconsider that decision in light of the downgrade.

Changes proposed to CPIH

CPIH is intended to address perceived shortcomings in CPI, namely to include an estimate of owner-occupiers’ housing costs.  Based on information now available, the UK Statistics Authority believes that its initial methods for calculating the housing component could be improved.

The ONS have suggested four improvements to the method of calculating housing costs.  These mainly revolve around improving the rate of sampling rental prices in the UK, so that they can more accurately reflect the rate at which rents have been rising.

Adopting these changes would mean that annual increases in CPIH over recent months could be 0.2 percentage points higher.

That increase could lead to a pensioner on an income of £10,000 receiving an additional £15,000 over their lifetime.  If a scheme is using CPIH to determine pension increases, the change in methodology could lead to an increase in its liabilities of as much as 4%.

This underlines the risks of adopting new measures that have not been tried and tested over time - the fact that CPIH appears to have been underestimated risks undermining confidence in national inflation measures.  Consistency is key for employers who prefer their pension contributions to remain stable.  While we do not expect that past values of CPIH will be recalculated, this is the latest in a series of uncertainties and changes which has complicated the seemingly simple act of increasing a pension from year to year.  The ONS could really help employers and pension schemes by publishing instead a measure of how the cost of living for an individual in the UK increases each year.

The Authority will undertake further work to improve CPIH in the autumn.  It is possible that CPIH will be reinstated as a National Statistic once this work is complete.

The same flaw affects both RPI and CPI but the ONS have commented that the improvements proposed do not have an appreciable impact on those indices.

Action for employers

This should prompt employers to consider:

• The index used for pension increases.
• The inflation risk present within their scheme.

We will be updating our note on switching to CPI pension increases shortly.