The Government could be forced to pay a compensation bill as big as the entire defence budget if a legal challenge launched today over the rejigging of the retail prices index succeeds.
Analysts estimate that the Treasury could in theory be forced to pay compensation of as much as £40 billion to holders of index-linked government bonds tied to the RPI if the Government loses.
The BT, Marks & Spencer and Ford UK pension schemes today begin their challenge to Chancellor Rishi Sunak in the Royal Courts of Justice in a hearing under Mr Justice Holgate.
In 2020 Sunak said he was changing the definition of RPI at the behest of the UK Statistics Authority to make it identical to CPIH, the consumer prices index adjusted for housing costs, with the change coming in from 2030.
RPI has long been discredited as a measure of the cost of living because of a methodological flaw in the way it is calculated and other drawbacks. It typically comes in at around 0.8-1 percentage point higher than CPIH each year.
However investors in the inflation-protected bonds, known as linkers, say that is irrelevant and that they bought the bonds — whose interest rate is determined by RPI — on the reasonable expectation that the terms would not be changed.
Ian Mills, a partner at actuaries Barnett Waddingham, said, the challenge was not expected to succeed, but if it did it could push up the cost of government borrowing and destabilise the gilts market. It could also give a large boost to linker holders as well as to people whose pension increases are linked to RPI.
“If compensation is paid then this would significantly improve pension scheme funding levels, but at a colossal cost to the taxpayer — the compensation figure could be greater than the UK’s annual defence budget.”
Many linkers are very long-dated, only maturing decades into the future, so their value has already been severely hit by the proposed change. Insight Investment has put the total cost to investors at as much as £100 billion. There are around £400 billion of outstanding linkers.
The BT scheme, which has 275,000 members, has previously calculated it would be £1 billion worse off because of the formula change.
A successful challenge could have adverse consequences for rail fares and interest on student loans, both of which are linked to RPI and so under Sunak’s current plans should rise by smaller amounts after 2030.
The case is expected to last two days. A judgment is not expected before September.
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The Treasury has argued that there is no case for compensation because linkers would still be linked to “RPI,” just a differently defined RPI.
The impact of a successful challenge would differ from pension scheme to pension scheme. Some lift pensions and preserved pensions each year according to the RPI, some by CPI, while on the assets side, some hold much larger stocks of linkers than others.
Jos Vermeulen at Insight Investment, a major investor in gilts, said, “£100 billion is at stake for pensioners”. Thousands of pension scheme members were going to receive lower pensions as a result of the plan, he said. Women particularly were going to be financially disadvantaged as they lived longer so would suffer more from the reduced inflation protection.