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From Captain Mike Post ...

(N.B.:- PLEASE SEE MIKE'S 'DECLARATION OF EMERGENCY FOLLOWING THIS FIRST POST)

'Dear All

This coming Wednesday, 25 November 2020, is significant because the Government’s response to the RPI Consultation is due to be announced. The very serious question that will be answered on Wednesday is, “Is the Government actually proposing to default on its debt obligations?”

The Public Consultation on the timing of changes to the methodology used to calculate the RPI which was published in April 2020 failed to make any mention at all of compensation to the very many people and institutions which signed up in good faith over many years to long-term contracts protected against inflation by the RPI. APS pensioners, the Airways and New Airways Pension Schemes and holders of UK issued Index Linked Gilts are examples of the numerous worldwide losers, should no compensation be paid.

The FT’s ‘Pensions Expert’ magazine has kindly given permission for two of their articles to be published in full. These articles are appended to the end of this mailing and clearly explain the issue. Here are some selected quotes:

· The proposed alignment of RPI with the housing variant of the consumer price index could see £100bn or more wiped off the value of pension scheme assets, with a 65-year-old losing 10 to 15 per cent of their income over a lifetime, according to analysis by Insight Investment.

· “It’s quite likely that some parties will consider challenging any government decision not to compensate bond holders – with around £700bn of index-linked gilts outstanding, the sums involved are so vast that if even if there’s only a slim chance of success, legal action may well be considered.”

· A more likely scenario, predicted Janet Brown, partner at Sackers, is that the government – wanting to retain its reputation as a debt seller – will want to resolve the inflation-linked gilts issue. “It will do something to head off the situation, either by giving compensation or having a notional RPI on such investments,” she said.

· The long-awaited outcome of a consultation on replacing the retail price index of inflation is set to be published on November 25, but investors have warned that the government’s timing risks violent market reactions.

· “More than 10m beneficiaries of DB pension schemes in the UK will learn on November 25 if they are collectively set to lose more than £100bn as a result of the RPI reform.”

No doubt the Government is hoping that its response to the public Consultation Response will be buried by the Chancellor of the Exchequer’s simultaneous presentation of his Public Spending Review. Let us hope that the Government does wish to retain its reputation aa an honest borrower and is planning to make provision to compensate losers from a change to the way the RPI is calculated.

Make no mistake that this will be a very significant event - not unconnected to the Government’s recently incurred massive borrowing requirement.

Regards to All

Mike Post

Pensions experts predict RPI limbo for years to come

By Stephanie Hawthorne | January 22, 2020

Experts have condemned delays in publishing a long-awaited consultation on reforms to the retail price index, since its outcome could radically alter the fortunes of pension funds and pensioners.

The proposed alignment of RPI with the housing variant of the consumer price index could see £100bn or more wiped off the value of pension scheme assets, with a 65-year-old losing 10 to 15 per cent of their income over a lifetime, according to analysis by Insight Investment.

Chancellor Sajid Javid announced the intention to merge the measures in September 2019, with a consultation due in January.

However earlier this month, Mr Javid announced that the consultation will be launched alongside the UK Budget in March, with a response expected before the parliamentary summer recess.

Schemes looking at insurance transactions may reconsider this type of activity as there is the potential for an increase in insurers’ costs to protect against an adverse consultation outcome

Niren Patel, Aviva Investors

While the policy has been proposed in response to the UK Statistics Authority's condemnation of RPI as a legacy index and poor measure of inflation, experts say the move will hurt some schemes and pensioners if compensation is not provided.

RPI generally runs at about 1 percentage point higher than the CPI, and is currently 2.2 per cent compared with a CPI of 1.5 per cent.

Consultancy LCP has calculated that the change could swing defined benefit funding levels by as much as 10 per cent, depending on the wording of their liability promises and their investment strategy.

Schemes grappling with uncertainty

Such huge sums and the current state of limbo “means that pension schemes cannot assess with any confidence future rates of the RPI”, said Ian Mills, senior investment consultant at Barnett Waddingham.

“It affects many different aspects of running a pension scheme,” he added.

“The supply of index-linked gilts, even on the present RPI basis, has been inadequate to meet demand, while the supply of CPI-linked gilts is almost non-existent.”

According to Ian Neale, director at Aries Insight, this delay prolongs a situation that has been increasingly unsatisfactory for DB schemes.

He said: “As the chancellor has ruled out any change before 2025 at the earliest, whether the next government – following the general election due in late 2024 under the Fixed Term Parliaments Act, unless it is repealed – will be bound by any decision this government makes is an open question.”

Real prospect of legal action

The government could also face a backlash from some pension schemes depending on its response to the consultation, experts warned.

Mr Mills said: “It’s quite likely that some parties will consider challenging any government decision not to compensate bond holders – with around £700bn of index-linked gilts outstanding, the sums involved are so vast that if even if there’s only a slim chance of success, legal action may well be considered.”

He explained that the calculation of inflation statistics has changed over time, and sometimes this has benefited bond holders.

“For example, there was a change to the methodology in 2010 that led to higher rates of RPI, favouring bond holders. Bond holders didn’t complain about that change,” Mr Mills added.

A more likely scenario, predicted Janet Brown, partner at Sackers, is that the government – wanting to retain its reputation as a debt seller – will want to resolve the inflation-linked gilts issue.

“It will do something to head off the situation, either by giving compensation or having a notional RPI on such investments,” she said.

Some RPI reforms have already been priced in, according to Derry Pickford, principal consultant at Aon’s asset allocation team.

He said: “The price of index-linked hedging assets has likely fallen in value already because of the possibility of changes. We estimate that the long end of the forward break-even curve shifted by about 20 basis points because of the announcement.

“The UK 2068 bond famously fell 14 per cent over the two trading days after the announcement, but probably only around half of this can be attributed to the chancellor’s letter.”

Pension schemes to rethink derisking activities

Given the potential for change, schemes implementing or adding to their liability-driven investment programmes may want to reassess the levels at which are they are comfortable buying inflation protection, warned Niren Patel, LDI portfolio manager at Aviva Investors.

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He added: “Schemes looking at insurance transactions – of which there were record volumes in 2020 – may reconsider this type of activity as there is the potential for an increase in insurers’ costs to protect against an adverse consultation outcome.”

Stephen Scholefield, partner at Pinsent Masons, noted that trustees and employers should now be thinking about how any change could affect them, so that they are well placed to respond to the consultation – “especially if they stand to be adversely affected”.

He added: “Those who are thinking about certain derisking activities should also keep this issue in mind. For example, giving members the option to swap RPI increases for something else has a new dynamic to it.”

RPI decision timing ‘risks volatility’

By Angus Peters | November 10, 2020

On the go: The long-awaited outcome of a consultation on replacing the retail price index of inflation is set to be published on November 25, but investors have warned that the government’s timing risks violent market reactions.

A consultation on replacing the RPI was launched in April this year by the Treasury and the UK Statistics Authority. Long criticised as a measure of the cost of living, the RPI has nonetheless been the index used for the uprating of inflation-linked gilts, the vast majority of corporate bonds, and most of the liabilities owed by UK defined benefit schemes.

Previous suggestions on how to replace the measure, floated by former chancellor Sajid Javid, involved bringing the methodology for calculating the RPI in line with that of the housing variant of the consumer pricing index, known as CPIH.

Without adequate compensation for holders of RPI assets, the effect could be a loss of as much as 20 per cent of income for some pensioners, according to modelling. The RPI typically runs around one percentage point higher than the CPIH.

Meanwhile, scheme professionals have warned of arbitrary and polarised effects on DB schemes, with funding level swings of 10 percentage points either way feasible, depending on the characteristics of individual schemes.

The government has met its promise to deliver a response by autumn, but some investors are worried that its proximity to the Christmas break, when liquidity typically dries up, could cause a bumpy ride when the decision is announced.

Jos Vermeulen, head of solution design at Insight Investment, commented: “More than 10m beneficiaries of DB pension schemes in the UK will learn on November 25 if they are collectively set to lose more than £100bn as a result of the RPI reform.

“In what has already been an extremely challenging year for the public and corporates, aligning the RPI with the CPIH, as per the proposal, will cause further misery for pensioners and sponsors of pension schemes with CPI-linked liabilities.”

Mr Vermeulen suggested that markets have priced in a “very high probability” that the RPI and the CPIH will be aligned with no margin to separate them, and warned of year-end volatility in inflation markets.

“We hope that the UK government and the UKSA have given careful consideration to the economic consequences of the RPI reform before making a final decision, and that they have listened to the broad community of stakeholders who participated in the consultation process earlier this year,” he said.

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PLEASE READ MIKE'S 'DECLARATION OF EMERGENCY' FOLLOWING BELOW:-

'Dear All

For the first time since I retired I am declaring an emergency.

Further to my mailing earlier today I have received feedback from one highly reputable financial journalist and one highly competent MP. They were both unaware that on the day after tomorrow, Wednesday , 25 November 2020, alongside the Spending Review the Government is publishing its response to the 11 March Consultation by Government and the UK Statistics Authority (UKSA) to the UKSA’s 11 March proposal “to address the shortcomings of the RPI”.

The UKSA’s 11 March proposals did not mention the need to compensate the very many individuals and institutions should the RPI be reduced by 1%. Should there be no compensation paid this would be a massive default by the British Government and it appears that the announcement will be smuggled through when the country is worried about other things. The Pensions and Lifetime Savings Association (PLSA) represents 1300 pension schemes with 20 million members and £1 trillion in assets. It has proposed: ”In order to transition away from the use of RPI in a fair and equitable way, we suggest the government and the UKSA deliberately adjust index-linked gilts from RPI to CPIH + X, where X is an agreed and transparently calculated adjustment reflecting the expected long term average future income of RPI over the new inflation measure. This solution is also commonly referred to within industry as “CPIH + a spread”. Alternatively, the Government may also wish to consider paying any future lost income to index-linked gilt holders upfront.” This proposal is supported by ABAP, by the APS Trustee and by the NAPS Trustee.

May I ask you to email your MP as a matter of emergency to make sure that he or she is aware that the Government might be planning to publish on Wednesday a document to announce a massive default on its obligations. This would be a seismic event which, amongst other devastations, would severely damage the pension prospects of APS and NAPS pensioners.

Regards to All

Mike Post

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