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Tangled Web for Pensions

Tangled Web for PensionsThis week, the Government's Pensions Minister, Steve Webb, made a seemingly simple statement that set in train a complex process that could deprive anyone who has, or expects to have, an occupational pension.

He said he was going to alter the uprating of future pensions to the Consumer Price Index (CPI) rather than the traditional Retail Price Index (RPI).

Given the threats of 25-40% cuts in public services we can expect, that doesn't seem too bad does it?. After all, they're more or less similar aren't they?

Well, not exactly. Broadly speaking the CPI is lower than the RPI (typically around 1% lower each year - accumulating to an estimated 16% reduction in the final year of a 'typical' pension payment - we are told).

It's lower because the RPI includes a number of things that are excluded from the CPI - like Mortgage payments and Council Tax. And when the Bank of England wants to control inflation, it puts interest rates up, which puts mortgage rates up, which increases the RPI - but, crucially, it doesn't affect the CPI.

The main differences between the two are:

Population base:
CPI includes all UK private and institutional households and foreign visitors to the UK. The RPI includes private households only and excludes the highest income households and pensioner households mainly dependent on state benefits; these excluded private households account for around 13 per cent of all UK household expenditure

Item coverage:
The most significant difference is that the CPI excludes a number of items relating to housing costs (such as mortgage interest payments, house depreciation and council tax) that are included in the RPI

Index methodology – formula:
The CPI uses the geometric mean whereas the RPI uses the arithmetic mean to combine individual prices at the first stage of aggregation

Item coding:
The CPI uses a standard international classification system whereas the RPI uses a system unique to itself and not used elsewhere. The different approaches reflect that the CPI is used to compare inflation rates across Europe so a standard framework is required; the RPI is mainly used within the United Kingdom only.

And Europe say everyone should use the CPI, because it is the measure they decided to use.

So how did he go about the change?

Well, Mr Webb must have thought that the fat-cat gold-plated local government pensions would be easy prey, and that giving the tea-drinking town hall wallahs a taste of the nasty medicine first (in the budget), would be widely supported by the public.

Once that hump was over, he could move on to the private occupational pensions (which he has now done) and, although he has not yet gone this far, there are grounds to believe that private pension savings are in his sights too.

He was partly right of course. Well, at least the media had been primed with stories about town hall pensions costing twice as much as anyone had previously thought. (Notably, that report omitted to mention the 'contribution holidays' that many local authorities had taken as they suspended their payments into the pension funds in the 1980's when such funds were in 'surplus')

But what Mr Webb has unleashed here is a monster that we think will come back to bite him.

'Beware the tangled web you weave when first you practice to deceive' couldn't be more appropriate.

The budget change from RPI to CPI uprating from next April, is going to apply to other things as well. We know he already has the indexation of benefits and tax credits in mind, and we expect he will also change to the CPI for a lot more things - like Index Linked National Savings Certificates. Government has already said it is reviewing how the CPI could be used for the indexation of taxes and duties (provided the change doesn't affect the Government's income)

The (apparent) argument for down rating Public Sector pensions in the budget was a cost saving measure. He reckons it would save £11 billion by 2014. Maybe it will. But to do so, it will have to take that amount from the pockets of those who work(ed) in public services.

But there may be other reasons for the change, as we shall see later.

Early last week however, he came cleaner when he said "The government believes the CPI provides a more appropriate measure of pension recipients' inflation experiences and is also consistent with the measure of inflation used by the Bank of England. We believe, therefore, it is right to use the same index in determining increases for all occupational pensions and payments made by the Pension Protection Fund (PPF) and Financial Assistance Scheme."

Now (whilst we don't agree with what he said) this didn't seem too earth-shattering to most people either. The PPF was set up in the wake of the Maxwell scandal where Government partly guarantees the pensions of employees whose firms go bust, leaving existing and future pensioners in the lurch. So these pensions were, in effect, worthless anyway - so, well, if they're worth nowt, its hard to get worked up about using lower uprating on these pensions than it is for the town hall wallahs. Isn't it?

But then, in a written statement, last Thursday, he said

"We believe, therefore, it is right to use the same index in determining increases for all occupational pensions."

After that, people started to take notice.

Increasing the scope to "all occupational pensions" means it now includes everyone who gets - or expects to get - a pension from their employer or former employer.

Cue a flurry of angry blogsite postings such as "Surely private pensions have rules which are, in effect, a contract between the scheme and their members. Clearly any scheme can change their rules but only subject to ratification by the trustees after consultation with members. How can the government instruct them how to pay out their pensions?"

and

"When I purchased my pension I entered into a legal agreement with my pension provider that it would be increased by RPI each year. I could have opted for a nil increase or a lesser % increase and obtained a higher initial pension payment. Who are the Government to now interfere with this private agreement."

and

"What are the Government doing? first they attack the public sector pensions and now they're attacking the private sector pension holders - who were busy helping the Government attack the public pension holders at the time. Talk about being stabbed in the back. How to lose friends and anger people - by David Cameron and Nick Clegg."

And the (probably public sector) response of...

"What makes people think that a contract for a private sector pension should be more legally binding than for those with a public sector pension. If the government can ride roughshod over the nurses and teachers, why should you think they won't do so with your hard working engineer or bank clerk. After all they can use the same unsustainable argument, they will say if a pension fund has a huge deficit like many have it proves that this change is desperately needed."

We suspect this drive to pinch from pensions comes at least in part from the logic of people like the CBI's Neil Carberry who has been saying "Statutory indexation is the biggest single regulatory cost borne by final salary schemes. We hope that the government will also table overriding legislation, to ensure that schemes whose rules currently prevent them from taking advantage of this change can do so."

That's 'fighting talk' and Government hasn't gone that far - at least not yet. But it is their direction of travel. And some people are saying they know the government has plans to introduce primary legislation to do just that. To override (or at least to enable the overriding of) agreements enshrined in existing pension trusts.

With its latest declared move, the Government believes it will save not just the £11bn of public sector money, but something over £120bn by applying it to all occupational pensions that use the default / minimum pension scheme. (and even more if they make an overriding law for existing pension agreements)

But the legal position here is really complicated.

Taking the public sector first.....

There is not a single scheme across the whole of the public sector. Terms and conditions for the pensions in the Civil Service in Whitehall differ markedly from those of local police employees and council workers, which are different again, as are health employees and the armed services and the Royal Mail (to name but a few).

And in addition to that complication, you have people who are just starting work in the public sector, those who have worked and left with an accrued entitlement to a future pension, those who are still in work, those who are already retired, and those who are the spouse of a deceased member, on a fractional pension for the rest of their lives.

The Civil Service Pensioners Alliance saw this coming of course, and before the election they "sought clarification from the three main political parties about their intentions." They received the following assurances.....

Angela Eagle said on behalf of the Labour Party "Following the agreement for change reached with the unions in 2005, we are satisfied that public sector pensions are affordable, sustainable and fair. We have no plans to change the current index-linking arrangements."

Steve Webb (the same chap who has is bringing in the changes) said (before the election) on behalf of the Liberal Democrats "We are very clear that all accrued rights should be honoured: a pension promise made should be a pension promise kept. Therefore we would not make any changes to pension rights that have already been built up. I have confirmed that I regard accrued index-linked rights as protected."

Philip Hammond said on behalf of the Conservatives "Indexation of pensions in payment is an established part of pensions legislation. The Conservative Party has no plans to change the current index-linking of public sector pensions in payment. We agree with the view that the right to indexation of pensions already accrued is part of the accrued pension rights and those rights will be protected. Our proposed £50,000 cap on public sector pension rights accrued was always intended to be a real-terms cap and therefore will be subject to indexation to reflect inflation. It would make no sense to express a long-term cap on pensions in nominal terms."

But the budget statement said

"The Government will uprate the basic State Pension by a triple guarantee of the highest of earnings, prices or 2.5 per cent from April 2011. The CPI will be used as the measure of prices, consistent with the Government's decision to index all benefits and tax credits by the CPI, although the basic State Pension will increase by at least the equivalent of the Retail Prices Index (RPI) in April 2011 to ensure its value is at least as generous as under previous uprating rules. The standard minimum income guarantee in Pension Credit will increase in April 2011 by the cash rise in a full basic State Pension."

As you'll see, although the quote was about the State Pension, there's a tacit admission here that the change from RPI to CPI will make folk worse off.

And there are also some carefully worded promises in the 'assurances' that were given as well - such as "not make any changes to pension rights that have already been built up" and "no plans to change the current index-linking of public sector pensions in payment"

In the private sector, there are even more variations between pension schemes. Some are statutorily linked to the RPI, others not. Some specify more than the RPI anyway, and others have nothing specified at all.

There will be people who worked for several employers, each with different sets of terms and conditions, and they could end up with their pensions being treated differently by each former employer.

So how does that work?

Well, in 1997, legislation was introduced that said private sector pensions had to be increased in line with inflation or 5% whichever was the lower (This has since been reduced to 2.5% by the Government). Many of the bigger schemes already had RPI (or better) written into their trust deeds, so it didn't matter for them. But over time, even some of them have been shifting down toward the minimum for uprating.

Advice coming from lawyers suggests that many private sector schemes expressly state the use of RPI, and these arrangements cannot be superseded without a rule change to the scheme. And even if the RPI link is broken, it is unlikely to be applied retrospectively.

(That's unless the Government passes primary legislation and changes the law of course!)

But if your scheme doesn't specify your pension will be uprated by the RPI, you can probably expect it to be paying less in the future.

This is because the 'default / minimum scheme' set out by Government only says it will be uprated by inflation, not WHICH inflation index. So if Government decides to use the CPI, they can do so at the stroke of a pen.

In local Government it's similar. The index-linking arrangements for public sector pensions are mostly contained in the Pension (Increase) Act 1971, but some are in the Social Security Act 1975. Whilst neither specifically states the RPI, the much amended 75 Act says "Where it appears to the Secretary of State that the general level of prices is greater at the end of the period under review than it was at the beginning of that period, he shall lay before Parliament the draft of an up-rating order….." So, each year since 1972, the Minister has laid such an order in parliament, and that order has always reflected the increase in the RPI as recorded for the previous September.

Almost all the official leaflets and booklets that provide advice and information on public sector pensions refer to pensions being increased by RPI, but in fact, the choice appears to be at the discretion of the Government. That will come as a shock to those in the public sector who have planned for pensions keeping pace with retail prices.

The CPI is usually less favourable than RPI and, had pensions been linked to the CPI for the past 10 years, they would now be worth about 12% less than they are currently. (So you will probably see things like industrial action threats, and legal challenges to the change from within the public sector).

The unfortunate part in all of this is that people in both public and private occupational pensions signed up for jobs with a known set of benefits, (salary / holidays / pension / car / healthcare) etc. That's the employee remuneration package they accept in exchange for guaranteeing exclusive hours to their employer.

Although we think proper defined benefits pensions should be the norm, we can see the argument for any employer changing employment T&C for its future starters. They will know what the offer is and whether its something they want to sign up to.

But we see no moral justification for any employer unilaterally changing the T&C of its existing employees - unless this is with their agreement - This group contracted with their employer for a defined set of benefits (including at least in some cases RPI indexation) as part of the job offer.

And we see no legal justification for an uprating reduction which is, in effect, a retrospective change in the T&C of former employees whose pensions are already in payment.

It's akin to breach of contract for existing and former employees.

It's believed that overall, somewhere between a quarter and a half of all current occupational pension schemes could be adversely affected.

That's a lot of people.

Some of the worst hit will be those with deferred benefits - people who have changed employer but are still due a pension from them eventually. They're worse off because they're likely to have longer to wait for their pension, and there's longer for the reduction to bite into their accrued pension entitlement.

This has rattled Government because on Monday, they rushed out a clarification statement. It said "occupational pension schemes will still have the freedom to pay more than the statutory minimum."

So if your scheme already specifies increases at, or in excess of the RPI, you're maybe OK - that is unless you're in the public sector, and unless your pension trustees agree to downgrade the increase if the Government uses primary legislation to allow them to override the existing agreements.

But if your scheme doesn't specify the RPI - you're in schtuck.

The Government also gave some helpful examples of how they thought it would work.....

"The following generalised simplified examples are provided for illustrative purposes only. These examples illustrate how these changes could apply to future calculations of the revaluation and indexation applying to pension rights, if a pension scheme adopted the statutory minimum approach. They would not affect pension payments already received. They do not deal with issues arising from contracting out from the State Second Pension. The detailed rules on revaluation and indexation vary between pension schemes and can be higher than the minimum. They also depend on when the pensionable service took place. Other factors may affect an individual’s pension entitlement depending on that scheme’s rules.

* A is a pensioner member of a pension scheme. His pension has been in payment for three years, and he has been receiving increases related to RPI. From 2011 his future increases will be calculated in relation to CPI. This does not affect his previous increases.

* B is a deferred member of a pension scheme. She left pensionable service five years ago. When she reaches normal pension age, her rights will be revalued in relation to RPI in respect of the first five years after she left pensionable service, and then in relation to CPI until normal pension age. Once her pension has been put into payment, she will receive annual increases calculated in relation to CPI.

* 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."

The Government said these examples are the default / minimum scheme - i.e. for those employees that don't have a better scheme written into their pension trust deed already. And for all public sector workers

Or at least, that's what the Government thinks will happen.

So it's going to be a lottery, based on the small print of your pension scheme (and maybe your industrial muscle).

There will be a sense of injustice when winners and losers emerge.

Whether you work in the private or public sector, moving the goal posts when it's too late to make alternative arrangements was always going to cause ructions, and we say that retrospective legislation - wherever it appears - is wrong in principle.

So we can see trouble brewing. And we wouldn't be surprised if it became 'Poll Tax' in scale now that half the country will be affected.

Bad judgement Mr Webb.

But it will be even worse when folk realise WHY its being done

One lady for whom counterbalance has quite a lot of time - Roz Altman - was quoted as saying "It was interesting that he [Osborne] seems to believe CPI will be a lower inflation number than RPI, because RPI includes house prices. Does that suggest that he's expecting interest rates to go up?"

We agree.

What's being missed are the real reasons why this is being done.

Yes it will 'save' cash toward the budget deficit; yes it will lower future government spending for its own employees; yes it will make institutions like the Royal Mail more attractive to buyers by reducing their future pension liability (we've heard it could wipe out the whole of their pension fund deficit at a stroke); and yes it will augur well for a future change to the uprating of all index linked transactions - such as personal pensions. (And not forgetting the 'by-product' benefits of reduced savings-side payouts for NS&I Index Linked savings and so on).

But chiefly it will do two other things. It will dampen the impact of increases in both mortgage interest and Council Tax (because CPI includes neither).

So in the longer term, the Bank of England can afford to let Council Tax increases run upwards - (Government is limiting these for the next two years, but after then the cap is coming off), and it can afford to let mortgage interest rates, rip ahead of the CPI, their new measure of 'inflation'

counterbalance does its own (RPI) inflation forecasts to help with household budgeting. Admittedly we are on the pessimistic side, but we've been pretty close over the last 18 months, and if, as we expect, RPI gets up toward 6% or 7% (or maybe even 10% depending on major economic events) around the New Year or early spring, and the CPI stays around 2% - 4% it will allow quite a chunk of our national debt to be (at least partly) inflated away by the Government, whilst pensioners and property owners will pay much of the price.

This is going to remind Jo Public that the banks and financial casinos that caused this problem; who blackmailed the government to print unimaginably large sums of money it didn't have; who then pocketed most of the ransom that this 'Quantative easing' (a euphemism for legalised forgery) represents, and who are even now hesitant about whether they can survive, will only continue to exist by stripping people of £200 billion of their pensions and mortgages.

When this realisation dawns, Jo public is going to be angry, and if there is primary legislation to override existing agreements that specify the RPI for uprating, there will be even greater anger. There are bumpy rides are ahead for many.

Why does this all matter?

Well, just do the sums.

If inflation is say, 5% a year, then after ten years, your savings of £10,000 will be worth £5,000 in real terms because half of it (10 x 5% = 50%) will have been lost to inflation over the term.

That's a great situation if you're in debt (because the real value of your debt will have halved) but for those with cash, robbery by inflation is a nightmare.

So if there's a 5% difference between the RPI and the CPI - and your uprating is changed to CPI - you could be much worse off.

That's why it matters.
 

Dated:   16 July 2010


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