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CPI versus RPI - The Inflation Con

by Ashley Clark, Director, October 2010

Last month we wrote about the “Winter of Discontent 2” and the use of inflation as a tool to reduce public sector debt.

Nothing much has changed our view that inflation will be used as a tool. Interest rates have not been increased, more quantitative easing is planned i.e. more money being ‘pumped’ into the economy and the budget changed the measure of inflation for many pensions and benefits.

Inflation Changed from RPI to CPI
Below we explain the impact of a change in the basis that inflation rates are calculated for pensions and benefits from 2011.

September Inflation Rate for April 2011
Research has suggested that the Government changing the basis for inflation measurement when paying pensions will save pension funds a third in costs.

Currently, increases in pensions in payment in April, are set by the inflation rate in September, this was published last week by the Office for National Statistics.

The September inflation rate affects state pension increases, SERPS and state second pension increases, benefits, public sector pensions and some private sector final salary pensions.

Inflation Change RPI to CPI (RPI = 4.6%pa, CPI = 3.1%pa)
The measurement for inflation was changed in the June Budget by the government from Retail Prices Index (RPI) to UK Consumer Prices Index (CPI).

CPI inflation in September was 3.1%, according to the Office for National Statistics (ONS) whereas RPI, the old measure of inflation, which includes mortgage costs and covers a narrower band of people, fell to 4.6%.

This means that pension in payment increases will be lower next April meaning an estimated saving for pension schemes of around a third.

RPI - The RPI covers a range of costs excluded from the CPI, including:

• Mortgage interest payments (MIPs)
• Council tax
• House depreciation
• Buildings insurance
• House purchase costs, e.g. estate agent fees
• TV licence
• Road fund licence
• Trades union subscriptions
• RPI includes a price index for cars which is based entirely on used
• car prices.
• The RPI is representative of the majority of private UK households, but excludes the highest earners and pensioner households dependent mainly on state benefits. It includes expenditure both within the UK and abroad by UK households.
  

CPI: The CPI covers certain charges and fees excluded from the RPI, including:

• Stockbroker fees
• University accommodation fees
• Foreign student tuition fees
• Unit trust feesThe index for the purchase of new cars in the CPI is quality adjusted and based on actual published prices for new cars.
• The CPI is representative of all private UK households, and also includes the expenditure of institutional households (nursing homes for example) and foreign visitors to the UK. Only expenditure within the UK is covered.
  

ROSSI index
This is a measure of inflation, defined as the all-items retail prices index excluding rent, mortgage interest payments, council tax and depreciation costs. The September Rossi index is used to update income-related benefits (e.g. Job Seekers Allowance / Income Support).
The index is named after Hugh Rossi, who was the social security minister responsible for its introduction. Introduction of the index was considered necessary in order to avoid double-counting housing and council tax costs (for which separate benefits are available) within the calculation of more general income-related benefits.

How Do The Inflation Changes Affect Me? ............

Public Sector Pensions and many company final salary pensions

• Old Increase Method: RPI (4.6%)
• New Increase Method: CPI (3.1%)

Jobseeker's Allowance, Income Support, Housing Benefit, and other income-related benefits

• Old Increase Method: The Rossi index of inflation - which does not include housing costs, rent and council tax
• New Increase Method: CPI (3.1%)

Disability Living Allowance, Carer's Allowance and other non income-related benefits

• Old Increase Method: RPI (4.6%)
• New Increase Method: CPI (3.1%)
  

State Pension

• Old Increase Method: RPI (4.6%) with a minimum 2.5% increase
• New Increase Method: RPI (4.6%) or CPI (3.1%) whichever is greater each year

Tax Credits

• Old Increase Method: RPI (4.6%)
• New Increase Method: CPI (3.1%)