The CPI Pension Swindle

Published in Investing on 30 November 2011

Is the reindexing of pensions cheating our old folk?

A little while ago, when I took a look at how inflation is measured, we saw how there are two different measures of rising prices used by the government, and they differ slightly.

The older Retail Price Index (RPI) is being replaced in the UK by the newer Consumer Price Index (CPI). But why, and what's the difference? Well, it's mainly that CPI excludes a number of housing-related items -- like council tax, mortgage interest, and buildings insurance.

And that, together with differences in the way the two measures are calculated, means that CPI tends to come out a bit lower than RPI. Could that possibly be the reason why things like ISA allowances and pensions have been shifted to CPI-linking rather than RPI-linking?

What's the difference?

It will save the government money, certainly, but is it morally right to exclude some of the items that many pensioners, and almost all tax-paying ISA investors, will still be paying for? To answer that, we need to know the likely difference in the two figures, and a working paper just out from the Office for Budget Responsibility (OBR) has made it clear.

It appears that from 1989 to 2011, the difference in the two measures was around 0.7 percentage points a year, with RPI inflation being steadily ahead. That might not sound much, but when inflation is only running at a few percent (even now it's only just above 5%), it's actually is quite a difference -- especially when compounded over a couple of decades.

Pensions eroding

And the gap is getting wider. The OBR reckons that in the future, the difference will most likely double, with RPI running ahead of CPI by 1.4 percentage points. Let's assume average CPI inflation for the next 10 years of 3%, which would put RPI inflation at 4.4%. What difference would that make to the basic state pension of £102 per week?

Well, under the old RPI-indexed scheme, by 2021 it would have risen to £157 per week. But since the change of indexing to use CPI, it will only be worth £137 per week -- 13% less. Admittedly, there is some additional protection for pensioners, in the form of what is known as the 'triple lock' -- this guarantees the state pension will increased by earnings, CPI or 2.5%, whichever is the highest. 

What do you reckon? Is the change to CPI indexing fair to pensioners, or should we have stuck to the old RPI measure? Do share your feelings, below.

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nuages0 30 Nov 2011 , 5:30pm

The article fails to point out that some pension schemes have RPI written into their rules, so members of those schemes will continue enjoy full inflation linking of their benefits (if you believe that RPI itself is a true measure of inflation).

So we have ended up with exactly the "small print lottery" which pensions minister Steve Webb explicitly said he wanted to avoid.

I can only think that this is a result of poor, rushed policy making and bad advice from civil servants, who didn't realise that the trust deeds of many schemes have RPI "hard coded" into them and that the articles of these deeds are legally binding on the schemes & their members.

It makes you wonder if all other coalition polices have been constructed in the same slipshod manner!

rober00 30 Nov 2011 , 6:16pm

Additionally there is now talk of not using the existing September figure for calculation. Instead the intention appears to be to use an averaging figure presumabley based on 12 months.

There was talk it would be used in the Autumn statement. In the end it was not used.

Perhaps this time such an average would have been higher than September figure.

No doubt one to watch out for in the future.

alsirat 30 Nov 2011 , 8:59pm

Let's be clear the switch to CPI is possibly the biggest single stealth move by a Government in history. pensions. The change from RPI to CPI also affects public sector pensions and those on welfare benefits. The decision to move to CPI was made in the Coalition's first budget in June 2010 and it was effective from April this year. The total |Government saving from this change will amount to over £11 billion a year by 2015-16 and grow each year afterwards. This is the biggest single contribution by to the Government's austerity measures.
So these austerity measures by the Government are in the main to be made from the budgets of lower income households.

Although the annual differences in the two measures of inflation are small -- on average, the CPI has been around 0.7 percentage points lower than the RPI in the past decade -- they quickly get big over time. Cumulatively, prices under the RPI have risen 53.6 per cent since 1996 and by 35.6 per cent on the CPI. Those are dramatic differences in public spending, and they feed through directly into household budgets.

The Government's argument (Steve Webb no less) is that for pensioners at least CPI reflects the inflation they actually experience and so is a much better measure of inflation than RPI. But never trust what the Government says. Let's look at CPI and RPI to see whether this is true. CPI covers a smaller basket of goods than the RPI, excluding, for example, mortgage interest payments, Council Tax, vehicle excise duty and TV licenses. Costs that the Government does not think pensioners incur.

The CPI oiks however say that RPI overstates inflation. It is true that RPI and CPI use a different mathematical formula. Because of this difference, the RPI would be (currently) around one percentage point higher than the CPI even if it covered the same set of goods.

There is however an uncomfortable fact in the way of the CPI gang's argument. The reason CPI is a poor measure of the cost of living (for anyone let alone pensioners) is that it was never intended to be one. It was invented by statisticians as a macroeconomic tool for use by central banks, that would give a comparable measure of price-changes across different countries. The reason CPI excludes certain important costs related to housing etc is not that they're unimportant, but that European countries couldn't agree on a comparable way of measuring them.

This is all very clever "untruths" by the Government and a wonderful smokescreen for cuts because it's complex, it's slow, it's technical and most people don't have the foggiest idea about what is going on. But the impact of the changes is profound. Skimming small amounts each year from the budgets of pensioners will mean that many who are managing to get by Ok today will be struggling in 10 years time and in 20 years will be in abject poverty.

UncleEbenezer 30 Nov 2011 , 11:25pm

The government is facing up to some difficult realities:
1. A long legacy of unsustainable pension promises.
2. It's problematic to go back on any part of your predecessors' pie-in-the-sky promises or implied promises (today's strikes).
3. And it's politically impossible to touch today's pensioners - the ones who are getting a far better deal than we can afford.

It's an ugly stealth move, but its net effect may be to rebalance the system a little and improve generational fairness.

sippquixote 01 Dec 2011 , 11:46am

Alsirat:
Mr Osborne stated that he would continue to upgrade welfare payments at RPI except working people's tax credit qwhich would not be increased.
Great incentives!

AlysonThomson 01 Dec 2011 , 12:18pm

nuages0:
I believe that the article is referring to Old Age Pensions from the Govt.

AlysonThomson 01 Dec 2011 , 12:22pm

The only other thing I'd like to say is that I gather my Old Age Pension will increase by £5-odds in April.
Who remembers Gordon Brown's 75p annual increase for pensioners? Labour the peoples' Party, my a-se!

hectorajg 01 Dec 2011 , 12:36pm



My own pension was caught up in this very nasty stealth tax. It is  a private sector fully funded scheme (at the last actuarial valuation), however as the scheme indexing  rules refer to increases as defined by government, I will in future get CPI. This  has nothing at all to do with affordability, but just as  nuages says monumental incompetence by Webb, so that circa 50% of private pensions get CPI and the rest RPI. This is undoubtedly the biggest stealth tax in pension history, it is also probably the most incompetent, as government are reducing the pension income of members of fully funded schemes.You really could not make it up!

kradnik 01 Dec 2011 , 12:36pm

Given that everyone needs to chip in to the 'saving' of the economy, the move to CPI pensions uprating is probably the least painful way of grabbing some money back from pensioners. However, two other points are relevant:
- the effective inflation rate for pensioners is often even higher that the published RPI (a greater proportion of the pensioners' income is spent on food and fuel, less on electronics, etc)
- the move to CPI has affected a number of previous public sector pensions, eg BT, so the negative impact on some pensioners is increased further.

RedundantHippie 01 Dec 2011 , 1:04pm

The switch to CPI affects Public Sector Pensions as well as State Pensions and is just another element in the assault on the likes of nurses and Council staff. However there is some doubt about the legality of applying this measure to existing Public Sector pensioners as the RPI was part of the contract when staff paid into their pension pot. There does not seem to be any provision that allows the Government to suddenly switch the annual revue to CPI just because it is lower than RPI. Strangely the Bank of England pension scheme will carry on using RPI for their annual increase!

mackeson29 01 Dec 2011 , 1:33pm

Funny, I thought Thatcher disconnected the state pension from RPI, during her first or second term ?

ScottishDavie 01 Dec 2011 , 2:42pm

@RedundantHippie Given yesterday's events this may not be the best time to admit to being a public sector pensioner but "I'm Spartacus". For nearly 20 years I paid for added years on my pension at full cost to me which at times almost equalled my mortgage payments. I did so on the clear understanding that I would receive RPI indexing. When I retired in March 2010 all the documents about my pension referred to RPI. A couple of months later I was f**ked over in the first ConDem budget and the change from RPI to CPI which didn't just affect my basic public sector pension but also the added years which I'd paid for out of my own pocket. I consider I've been the victim of (at best) mis-selling if not theft and fraud. Various bodies, including the Civil Service Pensioners Alliance, have taken the government to a Judicial Review the result of which is awaited. However the law is complicated and Unison, no less, are of the opinion that it would appear to give the government the necessary discretion to do what it did. Regrettably the legislation would seem to allow the government to estimate price increases “in such manner as it thinks fit” and if Unison are correct the outcome of the judicial review is likely to be in their favour.


hectorajg 01 Dec 2011 , 3:07pm

ScottishDavie.

If the Judicial Review is lost there is still:-


http://www.cspa.co.uk/

Also, whatever the outcome of the Judicial Review we will be pursuing the cases of those members who have bought particular financial packages based on actuarial tables, which assumed RPI. Such packages include purchase of added years; purchase of added pension; allocation of pension; conversion of lump sums into pension; pension splitting on divorce; transfer-in of pension benefits from non-public sector schemes; and actuarially-reduced pensions. There might be others. Undoubtedly, if such packages had been bought from the private sector, the politicians, the media and the Financial Services Authority would have been up in arms about “pensions miss-selling”. 
 
We have had encouraging initial advice from our solicitors and have had tentative discussions with Cabinet Office as to how such cases should be pursued. The Cabinet Office has maintained that it has acted within the scheme rules but, if specific complaints are made by members, they will have to deal with them under the terms of the Internal Disputes Resolution (IDR) procedures. We have argued that it would be sensible to take a number of “lead” cases in the first instance, with other cases being decided in the light of those. The likely route would be a complaint under the IDR procedures. If that were to be rejected, the case could be pursued with to the Pensions Ombudsman. If he were to reject, we could then pursue via the courts. 
 
All this will take time to work out. Nothing has yet been agreed. When we have completed our discussions with our solicitors and with the Cabinet Office, we will issue appropriate advice to members via our Pensioner magazine. Cabinet Office has confirmed that members will have three years from April 2011 in which to lodge complain

TIMPERLY 01 Dec 2011 , 6:19pm

Rober00

If inflation falls in 2012 which we are told will happen ( whether we believe it is another matter) then inflation in September 2012 should be lower than the average for the previous 6 months which os probably why it was not introduced

ScottishDavie 01 Dec 2011 , 8:25pm

Thanks hectorajg. Good to know you're on the case.

matchmade 02 Dec 2011 , 10:27am

Moan, moan, moan. Why has no-one mentioned that the Government has re-introduced the connection between state pensions and average earnings, which Margaret Thatcher removed and oh-so-generous New Labour failed to restore? Campaigners for senior citizens have been harping on about this for years, but now they have it, they go on about RPI-CPI, the removal of free bus passes and so on, as if they are god-given rights. Free bus passes and TV licenses and huge winter fuel payments for all pensioners, irrespective of income, are a relatively new phenomenon and should not be regarded as immune from cuts just because pensioners play the Old Age card.

As a working person I think pensioners shold stop harping on about the 75 pence rise a few years ago and remember that they will be getting a 5% increase in their state pension next year, whilst most ordinary people have wage freezes or wage cuts, or short-time working. I would *love* to be getting a 5% pay rise, but I'm not going to get one, and meanwhile I still have to pay taxes for today's state pensioners. They may beat their sticks on the ground and say "I paid my way and earned my entitlement" when they were working, but it's not a level playing-field: there were fewer pensioners in their day and they had much lower longevity so the workers had less to pay. Of course I'm willing to stand corrected if someone can show me that the real costs of state pensions and as a proportion of median income haven't increased, and are not likely to in future, but on the face of it pensions (and associated healthcare costs) should be more burdensome, given the retirement of the baby boomers and increased longevity.

I agree with UncleEbenezer: pension promises made decades ago were unsustainable. Please face economic realities: whatever a pension scheme may say in the small print about index-linking when it was dreamt up 20 or 40 years ago, no one anticipated the huge increases in longevity or the improvements in healthcare that have occurred in recent years. If people expect to receive full pensions in their late 80s or 90s when the original actuaries predicted the beneficiaries would shuffle off in their mid-70s, something has to give: even fully-funded schemes are highly vulnerable if the current increases in longevity and the deeply depressed real returns on investment continue, especially when pension schemes are obliged to put so much of their money into bonds to pay for current pensioners, to the detriment of the interests of current contributors, who really want growth, not dividends.

CunningCliff 02 Dec 2011 , 2:42pm

The government won its case in the High Court for moving from RPI to CPI indexing, see:

http://news.google.co.uk/news/more?pz=1&cf=all&ncl=dSmomfhsqggj1tMeeJzK2ptWoo6rM&topic=b

Cliff

VicHarrow 02 Dec 2011 , 9:33pm

In answer to the question posed by the article, the reply is that anyone who signed up to, was promised or who was offered RPI index linking is most certainly being cheated by a unilateral switch to CPI which, it seems, cannot even be challenged in the courts. The only reason for the government to make the switch, and do it without any consultation, is to save money.

Let's face it, why was CPI introduced in the first place? It was because being selective with the comparatives and excluding such nasties as mortgage interest, rent, council tax and buildings insurance (all of which were rising too fast for the government's liking at the time) from RPI to create CPI was a clever little wheeze to partially renege on promises to protect pensions and benefits from the ravages of inflation. Did we all suddenly stop paying mortgage interest, rent, council tax or insurance? Of course not!

I would not put it past this government to be now looking at the components of CPI to see what the current nasties are which could be excluded from a third version of the index to bring the figure down even further and save even more money. That they are robbing the poorest section of the community of a valuable and necessary protection while the rich grow ever richer at those poor people's expense seems not to bother the government in the slightest.

Having said that, there are sizeable swathes of the community who have been and are continuing to be forced into pension arrangements without any inflation protection at all and where the pensioner takes all the investment risks. If they have any length of retirement at all they will feel the pain of that in years to come as inflation progressively reduces what might have been a decent pension on retirement to a pittance. At 5% pa average inflation the purchasing power of your starting pension will be reduced by about 2/3rds over 20 years. Try living on that! Let us hope for their sakes that the predictions of a sudden and sustained major fall in inflation soon are correct.

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