The document discusses the implications of changing the inflation index used for UK pensions from RPI to CPI. It notes that legislative changes have proposed switching statutory indexation from RPI to CPI. It then examines some key differences between RPI and CPI, the impact on pension schemes and insurers, challenges in hedging inflation, and potential reactions and derisking strategies schemes may consider in response to the change. A survey of actuaries is also presented on their views regarding matching assets, moving schemes to CPI, long-term expectations for the CPI-RPI differential, and derisking options schemes may pursue.

1. © 2010 The Actuarial Profession  www.actuaries.org.uk
Robert Gardner, Redington
Jay Shah, Pension Corporation
Workshop session A:
RPI to CPI
Investment Implications
2 June 2011

2. The Inflation basket
1© 2010 The Actuarial Profession  www.actuaries.org.uk
RPI:
+ Financial Services

3. What has happened
2© 2010 The Actuarial Profession  www.actuaries.org.uk
Legislative changes
Proposed switch in
statutory indexation:
RPI to CPI
Implementation
8 December 2010
Consultation
launched
8 July 2010 6 April 2011

4. RPI vs. CPI
3© 2010 The Actuarial Profession  www.actuaries.org.uk
Why it’s happened
-2
-1
0
1
2
3
4
5
6
Percentage
RPI (y/y) CPI (y/y)
• CPI is BoE’s
benchmark for the
whole economy
• Only 7% of
pensioners have
an outstanding
mortgage
1
2
3
Standard Deviation:
•RPI 1.54
•CPI 1.01
Source: ONS
• (Reduce public pension liabilities...)

5. How it’s happened
4© 2010 The Actuarial Profession  www.actuaries.org.uk
Public sector
• Pensions in payment increases indexed to CPI,
• capped at 5%
Private
• No mandatory statutory override
• No enabling modification power
• No CPI underpin required
• New pension consultation requirement

6. Risk management
UK inflation – the long run
Long run difference
• Aggregate price changes
• Mathematical formula
• 2010 formula effect to
persist
• Permanent 0.3% difference
implied
• Long-run estimate of 1.2%
“wedge”.
5© 2010 The Actuarial Profession  www.actuaries.org.uk
Formula effect
Source: ONS

7. Risk management
UK inflation - April 2011
• CPI jumped from
4% to 4.5%
• Above forecasts of
4.1%
• RPI fell from 5.3%
to 5.2%...
6© 2010 The Actuarial Profession  www.actuaries.org.uk
0
1
2
3
4
5
6
Percentage
RPI (y/y) CPI (y/y)
CPI up, RPI down
Source: ONS, Redington

8. Risk management
Hedging inflation
7© 2010 The Actuarial Profession  www.actuaries.org.uk
-1.50
-1.00
-0.50
0.00
0.50
1.00
1.50
30y Swap Real Yield 30y Gilt Real Yield 30y Swap Spread (Swap Yield - Gilt Yield)
Finding relative value
Source: Bloomberg, Redington

9. Risk management
Hedging inflation
8© 2010 The Actuarial Profession  www.actuaries.org.uk
Hedging CPI
Physical assets
• CPI-linked gilts?
• Flight Plan
Consistent Assets
(FPCA)
• CPI bond market...?
CPI

10. Reaction of schemes looking to de-risk
• How does this impact us?
– In payment : RPI generally hard-coded
– In deferment : reference to statutory revaluation
• ETVs and PIE exercises put on hold
• Buy-in / Buy-out decisions delayed
9© 2010 The Actuarial Profession  www.actuaries.org.uk

11. Now – business as normal
10© 2010 The Actuarial Profession  www.actuaries.org.uk
Column: Stack
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
2004 2005 2006 2007 2008 2009 2010
(£ million)
Pension insurance
buyout / buy-in
Pension insurance buyout CAGR¹: 66%
Longevity insurance
Market growth maintained Transactions completed

12. Pension scheme view of CPI vs. RPI
11© 2010 The Actuarial Profession  www.actuaries.org.uk
RPI vs CPI Index: January 1988=100
75
100
125
150
175
200
225
1988
01
1989
01
1990
01
1991
01
1992
01
1993
01
1994
01
1995
01
1996
01
1997
01
1998
01
1999
01
2000
01
2001
01
2002
01
2003
01
2004
01
2005
01
2006
01
2007
01
2008
01
2009
01
2010
01
RPI rebased
CPI rebased

13. Insurer view of CPI vs. RPI
12© 2010 The Actuarial Profession  www.actuaries.org.uk
RPI vs CPI year on Year since 1989
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
1989
09
1990
09
1991
09
1992
09
1993
09
1994
09
1995
09
1996
09
1997
09
1998
09
1999
09
2000
09
2001
09
2002
09
2003
09
2004
09
2005
09
2006
09
2007
09
2008
09
2009
09
YoY % increase RPI
YoY % increase CPI

14. RPI vs. CPI – stochastic simulation – no
underpin
13© 2010 The Actuarial Profession  www.actuaries.org.uk
Source: Barrie and Hibbert

15. RPI vs. CPI – stochastic simulation – with
underpin!
14© 2010 The Actuarial Profession  www.actuaries.org.uk
Source: Barrie and Hibbert

16. Hedge with RPI
• 1 in 200 year test
• Basket of goods
• Methodology
• Political influence
• LPI (0,5) using CPI
• Annual vs compound
15© 2010 The Actuarial Profession  www.actuaries.org.uk

17. Hedge with CPI
16© 2010 The Actuarial Profession  www.actuaries.org.uk
• Investment Bank A : CPI vs RPI = 0.1%
• Investment Bank B : CPI v RPI = 0.2%
• Capacity available : Small
Instrument Approx market size
Indexed RPI gilts £270 bn
Indexed RPI bonds £30 bn
RPI Inflation swaps £100 bn
CPI linked Virtually nil

18. Insurer solutions
• Will insure on CPI but no discount to RPI
– Expected CPI under-run = cost of additional mismatch
risk capital
• Some insurers able to move from RPI to CPI in future
– In anticipation of CPI market opening up in future
– Part refund of premium
– To whom – scheme or company
– On a buy-in or buy-out?
• Differential pricing?
• Source CPI assets?
17© 2010 The Actuarial Profession  www.actuaries.org.uk

19. But general market movements more significant
18© 2010 The Actuarial Profession  www.actuaries.org.uk
• Affordability chart reflects approximate asset/liability mix of
the Scheme (c70% equities and 80% non-pensioners)
• Chart assumes scheme is fully funded initially – for an
underfunded scheme the volatility in the deficit will be much
larger

20. Our survey says...
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21. Survey Results
1. What proportion of inflation-linked liabilities are matched
with inflation hedging assets such as index-linked gilts,
inflation swaps or buy-in insurance policies:
20© 2010 The Actuarial Profession  www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
70%
0% - 25% 25% - 50% 50% - 75% 75% - 100%
Proportion of matching assets

22. Survey Results
2. Broadly what proportion specify statutory minimum
revaluation/indexation, i.e. they could automatically move
to CPI:
21© 2010 The Actuarial Profession  www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
70%
< 25% 25% - 50% 50 - 75% >75%
Proportion of schemes
Revaluation in deferment Benefit indexation in payment

23. Survey Results
3. For those that could automatically move to CPI, what
proportion will move (or have actually moved) to CPI
(rather than retain RPI):
22© 2010 The Actuarial Profession  www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
< 25% 25% - 50% 50 - 75% >75%
Proportion of schemes
Revaluation in deferment Benefit indexation in payment

24. Survey Results
4. In your view is it fair that schemes that can move to CPI
should move to CPI?
23© 2010 The Actuarial Profession  www.actuaries.org.uk
Yes
76%
No
24%

25. Survey Results
5. What is your long term expectation for CPI inflation
relative to RPI inflation:
24© 2010 The Actuarial Profession  www.actuaries.org.uk
0% 10% 20% 30% 40% 50% 60% 70%
Same as RPI
c.0.5% p.a. less than RPI
c.0.5% to 1% p.a. less than RPI
1% to 2% less than RPI

26. Survey Results
6. Of possible de-risking options, which of the following do
you think your schemes consider seriously over the next
3 years:
25© 2010 The Actuarial Profession  www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Buy-in or buy-
out
Longevity swap Liability
management
exercise
None Other
Unlikely Likely Almost certainly

27. Survey Results
26© 2010 The Actuarial Profession  www.actuaries.org.uk
6. Other:
“Growth asset reduction (and increased matching assets)”
“Changes to investment strategy”
“Reduce scheme benefits – cease accrual”
“Investment triggers”
“Dynamic de-risking using funding level triggers”
“LDI”
“Other asset strategies, e.g. contingent/asset backed
funding”

28. Survey Results
27© 2010 The Actuarial Profession  www.actuaries.org.uk
7. What impact has the CPI move had on schemes
considering de-risking?
“None”
“Funding level increase”
- put buy-in / buy-out back on the agenda
- speeded up growth asset de-risking
“Halted buy-in until market in CPI develops”
“Lack of CPI-linked instruments has made de-risking more difficult”
“Very little yet, many are still awaiting final legal advice on whether CPI
applies”
“Some are waiting for dust to settle before proceeding”

29. Questions or comments?
28© 2010 The Actuarial Profession  www.actuaries.org.uk
Jay Shah
• Co-Head of Business Origination
• Pension Corporation
• shahj@pensioncorporation.com
• Tel: + 44 20 7105 2111
Robert Gardner
• Co-Chief Executive
• Redington
• robert.gardner@redington.co.uk
• Tel: + 44 20 7250 3416
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