Market Economics | Interest Rate Strategy - BNP PARIBAS ...

C is an active member of a pension scheme. He is
continuing to accrue new rights. If he continues in
pensionable service until he reaches normal pension
age in (for example) 2015, revaluation will not apply.
Once his pension is in payment, he will receive
annual increases calculated in relation to CPI.
D is an active member of a pension scheme. She will
leave pensionable service in 2013, and will reach her
normal pension age in 2020 and begin to receive her
pension at that time. From 2013 to 2020 her rights
will be revalued in relation to CPI. Once her pension
is put into payment, she will receive annual increases
calculated in relation to CPI.”
Limited market impact of public pension
indexation change…
Public pension funds are believed to be in the order
of around GBP 1trn (on a gilt-discounted basis) and,
to the extent they are largely unfunded and
unhedged, have limited impact on the RPI market
with future PF obligations paid from public coffers.
Local authorities, in contrast, do hold assets against
their PF liabilities but are much smaller (20%) whilst
their index-linked holdings are thought to be relatively
small (< GBP 10bn). Future inflation hedging demand
by these entities will most likely manifest itself in CPI
space, not RPI.
… But complexity over impact on private PFs
The statutory minimum indexation benefit for PF
members, also known as ‘general level of prices in
Great Britain’ – published annually will use CPI not
RPI from September 2010. The impact (on private
pension fund solvency and RPI linked assets) is
highly uncertain as different indexation rules apply to
deferred pensions, pensioners and Guaranteed
Minimum Pensions. Chart 1 illustrates the distribution
of member types according to the Pensions
Regulator. Equally important is the precise proportion
of private sector defined-benefit (DB) pension funds
that are linked to the ‘general level of prices’ without
explicit reference to RPI (or LPI) which is currently
unknown. Individual corporate pension funds will
likely be examining their trust deeds and potentially
holding trustee meetings to analyse the impact of the
proposed changes on their members’ benefits and
solvency levels.
The DWP communiqué on 12 July does provide
some clarity following Steve Webb’s written
statement to the House of Commons regarding the
shift to CPI. It illustrates that, with respect to deferred
members, the proposed changes will only apply to
future valuations. A report by actuaries Lane, Clarke
& Peacock suggests most deferred pensions refer to
the ‘general level of prices’ and thus would be
impacted by the switch to CPI indexation but this is
subject to reference in the Trust Deed. Pensioners
Chart 1: Distribution of Member Types
Pensioners,
36%
Active
Members, 21%
Deferred
Members, 43%
Active Members
Deferred Members
Pensioners
Chart 2: Aggregate Private PF Assets,
Liabilities, Surplus (PPF7800) and Potential
Impact of Legislative Change
200000
150000
100000
50000
0
-50000
-100000
-150000
-200000
Surplus
Assets £m Rhs
Liabilities £m Rhs
Potential Range
of Impact on
Agg. PF Surplus
-250000
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Sources: Purple Book 2009 The Pensions Regulator, BNP Paribas
1200000
1000000
800000
600000
400000
200000
will switch to CPI indexation as soon as the law is
implemented (likely start in 2011 based on Sep-10
CPI y/y) if there is no explicit reference to RPI (or LPI
linkage) in the trust deed which is not thought to be
the average case. Active members’ liabilities are
linked to salaries, which are typically modelled as
RPI + x% and the proposed legislation does not
change this unless there is a consensual move to
CPI + y% (which may introduce basis risk). At
retirement or deferment, PFs are treated as
described above. We do not purport to provide a
complete overview of pension fund legislation
changes here and would suggest affected
counterparties consult professional legal and pension
fund advice. In this context, we have used a report
titled ‘Red Views – Changes to Pension Indexation’
by Reddington (Consultants) as an information
source.
As of end June-10, aggregate Private PF assets
totalled GBP 901bn vs. liabilities of GBP 923bn,
leaving PF in an aggregate deficit of GBP 21.8bn
based on PPF7800 data – Chart 1. The PPF’s Purple
Book 2009 found the aggregate funding position
would deteriorate by 0.9-1% for each 0.1% rise in
inflation – See Table 1. The RPI/CPI spread is
volatile and very cyclical due to the housing
components, specifically MIPS and Housing
depreciation (Chart 3), whilst RPI’s arithmetic
0
Herve Cros/Shahid Ladha 16 July 2010
Market Mover, Non-Objective Research Section
40
www.GlobalMarkets.bnpparibas.com