Private sector UK pension schemes are to be indexed according to the consumer price index (CPI) rather than the retail price index (RPI). The RPI is typically around 0.5% higher than the CPI because it does not include house prices or mortgage payments. In a country with such high accommodation costs as the United Kingdom, it could be argued that the CPI is artificially low.
Accordingly, the change in the indexation rules will effectively mean that employers are not going to be obliged to pay their former employees as much as when their obligations were indexed using the RPI.
Since they came to power, the coalition government has engaged in some heavy rhetoric about bring public sector pensions under control. A commission is currently looking into the issue and swingeing cuts are expected. However, in the interests of fairness, the government has seen fit to bring the indexation rules for both private and public sector pensions into line. Unfortunately for private sector workers, this means that they will come down to the lowest common denominator – the CPI.
Employers are likely to welcome this change, as it decreases the burden on the schemes. Not only does the change mean that the amounts they pay out on a month to month basis will be less, but it also means that the schemes look more sustainable in the long term. This is an important consideration as it seems that every week there is a news story of another final salary scheme closing or being under threat from closure.
Any payments made by the Pension Protection Fund will also be indexed according to the CPI, which will also take a bit of pressure off that organisation.
So what will this mean for individual pensioners and workers? Some commentators have put the decrease in their expected pensions as between 10% and 25% – a significant change no matter how well off you are.