CPI liabilities: the wedge and the hedge

Running RPI-linked assets versus CPI-linked liabilities can pose material risks. But as pension schemes become better hedged – and market pricing becomes more appealing – they may seek to explore CPI-linked assets in greater detail.

A number of factors have affected the liabilities of defined benefit (DB) pension schemes in recent years, not least transfers out and changes in longevity assumptions. In addition, an increasingly illiquid market for instruments that hedge limited price indexation (LPI) liabilities has led some schemes to change their approach to calculating their liability benchmarks.

In this note, we consider yet another important source of scheme risk: that arising from the mismatch between liabilities linked to the consumer price index (CPI) and assets linked to the retail price index (RPI). This area has received increased attention of late, after a House of Lords inquiry recently criticised the UK Statistics Authority stance with respect to RPI (describing its position as “untenable”) whilst at the same time recommending that the “government should begin to issue CPI-linked gilts and stop issuing RPI-linked gilts”.