KPMG Survey Shows CPI Measure Cuts Private Pension Liabilities by Billions

(March 22, 2011) — KPMG’s 2011 Pensions Accounting Survey has revealed that the calculated value of UK private pension liabilities is declining following the announcement of the government’s plans to use consumer price index (CPI) to measure inflation.

The switch to CPI comes as a result of the UK government’s belief that it is a more appropriate measure of the price increases faced by pensioners. Since the switch, many companies have seen big improvements in their reported pension deficits over 2010/11.

“This period of relative stability gives corporates a strong platform to implement risk reduction strategies,” Mike Smedley, Pensions Partner at KPMG in the UK, said in a statement. “Whilst deficits have fallen, rising asset and liability values mean that schemes look bigger relative to the corporate sponsor. Strategies to remove liabilities or risk must be at the front of the corporate agenda. The provision of CPI linked pension increases across many schemes also creates a demand for CPI linked government debt, time will tell whether the Debt Management Office reacts to this.”

The study claims that using CPI as the measure of pension inflation, rather than the Retail Prices Index (RPI), will wipe out nearly $98 billion (£60 billion) from private sector liabilities by the end of 2011.

Already, the switch to CPI as the measure of inflation has erased about £25 billion in liabilities from defined benefit pension schemes, the firm notes. Furthermore, the group indicates that just over 50% of the companies it surveyed are now using CPI for certain benefit increases, with a typical rate of 2.9% being used, a percentage significantly lower than the average rate of 3.5% for pensions relying on RPI.

KPMG’s Smedley added: “Our sample’s assumptions that life expectancies are stabilizing contrast with data out today showing that overall UK life expectancies are still increasing,” He outlined a number of reasons for this. “First, our sample is looking at assumed life expectancies for people who have already reached a particular age (usually 45 or 65) as opposed to from birth. Second, companies have been ‘baking in’ increasing life expectancies for some time. And thirdly, corporates make assumptions based on actuarial data relating to their particular scheme members which usually differs from the population as a whole.”

Other effects of the switch to CPI on pensions are found in an earlier study by Hymans Robertson, which discovered that along with improved market conditions, the change to the CPI inflation measure has contributed to the flood of pension risk transfers. “Hymans Robertson’s analysis illustrates that Q3 2010 is the ‘calm before the storm’ for the pension scheme risk transfer market,” commented James Mullins, senior liability management specialist at the firm. “Many of the banks and insurance companies acknowledge that they are currently devoting serious resource to around 20 large pension scheme risk transfer projects.” He added that banks and insurance companies continue to offer new flexibility to help make risk transfers accessible to all pension schemes.

According to Hymans Robertson, by the end of September 2010, nine FTSE 100 companies had already completed such deals, with total transfers valued at £6.5 billion. By the end of 2012, the firm expects one in four FTSE 100 companies to have completed a material pension scheme risk transfer deal. The latest deal — a £124 million buy-in with Aviva by Next makes up a majority of the £500 million spent between July and September, and Hymans Robertson predicted the figure to rise significantly.

Separately, Mercer has published its own research targeting the buy-in market, and notes that the switch to CPI will have a positive impact on buy-ins. Yet, it said the UK will need to develop a liquid market for CPI-linked assets before the benefits will be enjoyed. The National Association of Pension Funds also expressed a tone of caution, warning that linking UK pension schemes to CPI rather than RPI could lead to a misalignment of investments versus liabilities.