Change to RPI inflation calculation could benefit pension scheme owners, expert says

The Office for National Statistics (ONS) is to publish a "range of options" setting out potential changes to the formula used to calculate the rate next month, it has announced. The changes are intended to address the so-called 'formula effect gap' caused by the different methods of calculating RPI and the other common measure of inflation, the Consumer Prices Index (CPI).

Pensions law expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that although since 2011 the statutory rate for increasing pensions and revaluing deferred benefits has been based on the generally lower CPI rather than RPI, many defined benefit schemes still have RPI 'hard-wired' into their rules.

"Those schemes were not able to take advantage of the switch," he said. "If the formula for RPI is revised so that it equates with CPI, the unfairness to those schemes will be removed. They will benefit from the same funding boost that most schemes benefitted from at the beginning of 2011."

However pension and insurance funds which invest heavily in gilts could lose out as a result of the changes.

The options for change which will be considered during the consultation process could include removing the formula effect gap altogether. Based on last month's figures, this change could reduce RPI by 0.88%. However, the Chancellor of the Exchequer must give his consent to the change if the Bank of England feels it amounts to a "fundamental change" to the basic calculation of RPI which would be "materially detrimental to the interests of index-linked gilts.

Currently, the formula for calculating CPI considers the spending behaviour of people who might switch to cheaper alternatives as prices increase including pensioners, foreign visitors to the UK and students in halls of residence. RPI, on the other hand, excludes the top 4% of households by income, institutional households and pensioner households which derive three quarters of their income through state pensions and benefits.

However, changing the calculation method will not result in the CPI and RPI rates becoming equal as the CPU does not include changes to the cost of housing - including mortgage interest payments, house depreciation and council tax.

The CPI rate was 2.5% in August compared to 2.6% in July, while RPI fell to 2.9% from 3.2% in July.

The cost of a range of other products including regulated rail fares, utility charges and taxes on beer and cigarettes are all linked to RPI. The Government changed the uprating method for public sector pensions and state benefits to CPI last year, meaning that these would not be affected.