By Sarah Brown
For those of us who find inflation interesting, it’s been an exciting twelve months. Every evening as I stroll past my local petrol station, I have been known to exclaim “look at that!” as night by night the price seemed to tumble, only to start to creep back up again.
As a relatively infrequent motorist, these developments were of mostly academic interest as they lead me to speculate on the future rates of price inflation as measured by the RPI and the CPI. In contrast my personal inflation rate is likely to differ from either of these measures and would need its own unique basket of goods, perhaps with an allowance for a personal statistician to determine the most appropriate method of averaging to capture my individual shopping habits – do I substitute for a cheaper product when prices rise, or do I remain loyal to my favourite brands?
I am not alone in such ponderings, as demonstrated by the findings of a recent review of consumer price statistics commissioned by the UK Statistics Authority and carried out by Paul Johnson of the Institute for Fiscal Studies. Johnson’s report observed that “inflation” can mean a range of different things – for example, the increase in prices between two dates is a subtly different concept to the increase in spending required to achieve the same level of welfare in the face of rising prices. Coupling this observation with the myriad of different inflation measures already available, choosing an appropriate personal measure becomes a tricky task.
So, if it is difficult for an individual to determine the best measure of inflation for them, how do trustees, employers and members agree on a suitable measure to use for pension scheme promises that were built up when the RPI was the main measure of inflation used in the UK? For many schemes, the answer is simple – the rules are clear over which measure should be used (usually, the RPI or the CPI) in different circumstances.
However, recent court cases have shown that scheme rules are not always clear, and with CPI inflation generally expected to be lower than RPI inflation, the difference can be material both to the benefits received by members and to the overall cost of the pension scheme.
Johnson’s report has added further fuel to this debate as he concluded that the RPI is no longer a suitable measure of inflation, as it does not meet statistical best practice and excludes certain households. Indeed, Johnson recommended that the use of the RPI should be ended as soon as practicable (while acknowledging that it seems impossible to do so in the short term).
In view of this, trustees and employers should not only look to the petrol pumps as a barometer of the size of their schemes’ benefits but also consider whether they are using the right measure of inflation under their rules and the potential costs or savings if that measure were to change.
Sarah Brown is senior consultant at Punter Southall
Comments