RPI to CPI - Investment Implications

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RPI to CPI - Investment Implications

  1. 1. © 2010 The Actuarial Profession  www.actuaries.org.ukRobert Gardner, RedingtonJay Shah, Pension CorporationWorkshop session A:RPI to CPIInvestment Implications2 June 2011
  2. 2. The Inflation basket1© 2010 The Actuarial Profession  www.actuaries.org.ukRPI:+ Financial Services
  3. 3. What has happened2© 2010 The Actuarial Profession  www.actuaries.org.ukLegislative changesProposed switch instatutory indexation:RPI to CPIImplementation8 December 2010Consultationlaunched8 July 2010 6 April 2011
  4. 4. RPI vs. CPI3© 2010 The Actuarial Profession  www.actuaries.org.ukWhy it’s happened-2-10123456PercentageRPI (y/y) CPI (y/y)• CPI is BoE’sbenchmark for thewhole economy• Only 7% ofpensioners havean outstandingmortgage123Standard Deviation:•RPI 1.54•CPI 1.01Source: ONS• (Reduce public pension liabilities...)
  5. 5. How it’s happened4© 2010 The Actuarial Profession  www.actuaries.org.ukPublic 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. 6. Risk managementUK inflation – the long runLong run difference• Aggregate price changes• Mathematical formula• 2010 formula effect topersist• Permanent 0.3% differenceimplied• Long-run estimate of 1.2%“wedge”.5© 2010 The Actuarial Profession  www.actuaries.org.ukFormula effectSource: ONS
  7. 7. Risk managementUK inflation - April 2011• CPI jumped from4% to 4.5%• Above forecasts of4.1%• RPI fell from 5.3%to 5.2%...6© 2010 The Actuarial Profession  www.actuaries.org.uk0123456PercentageRPI (y/y) CPI (y/y)CPI up, RPI downSource: ONS, Redington
  8. 8. Risk managementHedging inflation7© 2010 The Actuarial Profession  www.actuaries.org.uk-1.50-1.00-0.500.000.501.001.5030y Swap Real Yield 30y Gilt Real Yield 30y Swap Spread (Swap Yield - Gilt Yield)Finding relative valueSource: Bloomberg, Redington
  9. 9. Risk managementHedging inflation8© 2010 The Actuarial Profession  www.actuaries.org.ukHedging CPIPhysical assets• CPI-linked gilts?• Flight PlanConsistent Assets(FPCA)• CPI bond market...?CPI
  10. 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 delayed9© 2010 The Actuarial Profession  www.actuaries.org.uk
  11. 11. Now – business as normal10© 2010 The Actuarial Profession  www.actuaries.org.ukColumn: Stack01,0002,0003,0004,0005,0006,0007,0008,0009,0002004 2005 2006 2007 2008 2009 2010(£ million)Pension insurancebuyout / buy-inPension insurance buyout CAGR¹: 66%Longevity insuranceMarket growth maintained Transactions completed
  12. 12. Pension scheme view of CPI vs. RPI11© 2010 The Actuarial Profession  www.actuaries.org.ukRPI vs CPI Index: January 1988=10075100125150175200225198801198901199001199101199201199301199401199501199601199701199801199901200001200101200201200301200401200501200601200701200801200901201001RPI rebasedCPI rebased
  13. 13. Insurer view of CPI vs. RPI12© 2010 The Actuarial Profession  www.actuaries.org.ukRPI 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%198909199009199109199209199309199409199509199609199709199809199909200009200109200209200309200409200509200609200709200809200909YoY % increase RPIYoY % increase CPI
  14. 14. RPI vs. CPI – stochastic simulation – nounderpin13© 2010 The Actuarial Profession  www.actuaries.org.ukSource: Barrie and Hibbert
  15. 15. RPI vs. CPI – stochastic simulation – withunderpin!14© 2010 The Actuarial Profession  www.actuaries.org.ukSource: Barrie and Hibbert
  16. 16. Hedge with RPI• 1 in 200 year test• Basket of goods• Methodology• Political influence• LPI (0,5) using CPI• Annual vs compound15© 2010 The Actuarial Profession  www.actuaries.org.uk
  17. 17. Hedge with CPI16© 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 : SmallInstrument Approx market sizeIndexed RPI gilts £270 bnIndexed RPI bonds £30 bnRPI Inflation swaps £100 bnCPI linked Virtually nil
  18. 18. Insurer solutions• Will insure on CPI but no discount to RPI– Expected CPI under-run = cost of additional mismatchrisk 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. 19. But general market movements more significant18© 2010 The Actuarial Profession  www.actuaries.org.uk• Affordability chart reflects approximate asset/liability mix ofthe Scheme (c70% equities and 80% non-pensioners)• Chart assumes scheme is fully funded initially – for anunderfunded scheme the volatility in the deficit will be muchlarger
  20. 20. Our survey says...© 2010 The Actuarial Profession  www.actuaries.org.uk
  21. 21. Survey Results1. What proportion of inflation-linked liabilities are matchedwith inflation hedging assets such as index-linked gilts,inflation swaps or buy-in insurance policies:20© 2010 The Actuarial Profession  www.actuaries.org.uk0%10%20%30%40%50%60%70%0% - 25% 25% - 50% 50% - 75% 75% - 100%Proportion of matching assets
  22. 22. Survey Results2. Broadly what proportion specify statutory minimumrevaluation/indexation, i.e. they could automatically moveto CPI:21© 2010 The Actuarial Profession  www.actuaries.org.uk0%10%20%30%40%50%60%70%< 25% 25% - 50% 50 - 75% >75%Proportion of schemesRevaluation in deferment Benefit indexation in payment
  23. 23. Survey Results3. For those that could automatically move to CPI, whatproportion will move (or have actually moved) to CPI(rather than retain RPI):22© 2010 The Actuarial Profession  www.actuaries.org.uk0%10%20%30%40%50%60%70%80%90%100%< 25% 25% - 50% 50 - 75% >75%Proportion of schemesRevaluation in deferment Benefit indexation in payment
  24. 24. Survey Results4. In your view is it fair that schemes that can move to CPIshould move to CPI?23© 2010 The Actuarial Profession  www.actuaries.org.ukYes76%No24%
  25. 25. Survey Results5. What is your long term expectation for CPI inflationrelative to RPI inflation:24© 2010 The Actuarial Profession  www.actuaries.org.uk0% 10% 20% 30% 40% 50% 60% 70%Same as RPIc.0.5% p.a. less than RPIc.0.5% to 1% p.a. less than RPI1% to 2% less than RPI
  26. 26. Survey Results6. Of possible de-risking options, which of the following doyou think your schemes consider seriously over the next3 years:25© 2010 The Actuarial Profession  www.actuaries.org.uk0%10%20%30%40%50%60%70%80%90%Buy-in or buy-outLongevity swap LiabilitymanagementexerciseNone OtherUnlikely Likely Almost certainly
  27. 27. Survey Results26© 2010 The Actuarial Profession  www.actuaries.org.uk6. 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 backedfunding”
  28. 28. Survey Results27© 2010 The Actuarial Profession  www.actuaries.org.uk7. What impact has the CPI move had on schemesconsidering 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 CPIapplies”“Some are waiting for dust to settle before proceeding”
  29. 29. Questions or comments?28© 2010 The Actuarial Profession  www.actuaries.org.ukJay Shah• Co-Head of Business Origination• Pension Corporation• shahj@pensioncorporation.com• Tel: + 44 20 7105 2111Robert Gardner• Co-Chief Executive• Redington• robert.gardner@redington.co.uk• Tel: + 44 20 7250 3416 In addition... http://twitter.com/robertjgardner http://uk.linkedin.com/in/robertjgardner

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