On 18 September 2012, the Consumer Prices Advisory Committee (CPAC) announced potential future changes to the method of calculating the RPI inflation index1. These proposals could result in future RPI inflation moving closer to the CPI measure of inflation, which is generally lower.

Fundamental review of the calculation of RPI and CPI

The consultation starts on 8 October and ends on 30 November 2012. Any changes will be announced in January 2012 and implemented in March 2013.

The four choices are:

  • no change to current calculation methodology;
  • a change to the relevant averaging methodology in the clothing sector (i.e. the sector where the differences between RPI and CPI are largest);
  • a change to the relevant averaging methodology in all areas;
  • full alignment of the formulae for calculating RPI and CPI.

The outcome could vary from “no change” to the complete revision of the way the RPI is calculated.

The CPAC proposes the other differences between RPI and CPI (such as the different baskets of goods) will be left unchanged, although, separately, there is pressure to change the basis of housing cost included within the CPI calculation, which would further align the two measures.

Impact

The RPI, like the CPI, measures inflation with reference to the changing cost of a fixed basket of goods and services. Since April 2011 the CPI has been used for the indexation of benefits, tax credits and public service pensions. The CPI takes the geometric mean of prices to aggregate items at the lowest levels, instead of the arithmetic mean used for RPI. This means that the CPI will generally be lower than the RPI.

Detailed analysis of the switch from RPI to CPI for pension purposes is available here:

Switching pension increases from RPI to CPI, and Pensions increases: RPI or CPI?

In 2012, in the QinetiQ case2, the High Court was asked to decide whether the definition of “Index” allowed the trustees to move from an RPI basis to a CPI basis for calculating future pension increases and revaluation of deferred pensions.

Many schemes will include a QinetiQ-style definition of “Index” for pension increases and revaluation which broadly refers to “RPI or any other suitable index selected by the trustees”.

In the QinetiQ case, the High Court ruled that this wording allowed the trustees to adopt a CPI basis of calculation in place of RPI without affecting members’ accrued rights, which are protected by section 67 Pensions Act 1995.

Employers are, in general, keen for trustees to move to a CPI basis, which would significantly reduce a scheme’s funding deficit. However, trustees may feel uncomfortable with making such a change which, notwithstanding the QinetiQ case, may not be in the best interests of members. A radical overhaul of the calculation of RPI may help to resolve, or at the very least minimise, this conflict.

We will continue to check developments and report further.