Investment Implications of RPI to CPI
-
Upload
redington -
Category
Economy & Finance
-
view
39 -
download
1
Transcript of Investment Implications of RPI to CPI
![Page 1: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/1.jpg)
© 2010 The Actuarial Profession www.actuaries.org.uk
Robert Gardner, Redington David Collinson, Pension Corporation
Investment Implications
of RPI to CPI
13 March 2012
![Page 2: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/2.jpg)
The Inflation basket
1 © 2010 The Actuarial Profession www.actuaries.org.uk
RPI:
+ Financial Services
![Page 3: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/3.jpg)
RPI vs. CPI
2 © 2010 The Actuarial Profession www.actuaries.org.uk
Why it’s happened
• CPI is BoE’s
benchmark for the
whole economy
• Only 7% of
pensioners have an
outstanding
mortgage
•(Reduce public
pension liabilities...)
1
2
3
Standard Deviation:
•RPI 1.58
•CPI 1.15
Source: ONS
-2
-1
0
1
2
3
4
5
6
Jan 2000
Jan 2001
Jan 2002
Jan 2003
Jan 2004
Jan 2005
Jan 2006
Jan 2007
Jan 2008
Jan 2009
Jan 2010
Jan 2011
Jan 2011
Perc
en
tag
e
RPI (y/y) CPI (y/y)
![Page 4: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/4.jpg)
How it’s happened
3 © 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
![Page 5: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/5.jpg)
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”.
4 © 2010 The Actuarial Profession www.actuaries.org.uk
Formula effect
Source: ONS
![Page 6: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/6.jpg)
• Sharp fall in both
RPI and CPI since
September 2011
• RPI at 3.9% in
January vs. 3.6%
for CPI
• Spread at narrowest
since early 2010
Risk management UK inflation - January 2012
5 © 2010 The Actuarial Profession www.actuaries.org.uk
CPI and RPI down
Source: ONS, Redington
0
1
2
3
4
5
6
Perc
en
tag
e
RPI (y/y) CPI (y/y)
![Page 7: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/7.jpg)
Risk management Hedging inflation
6 © 2010 The Actuarial Profession www.actuaries.org.uk
Finding relative value
Source: Bloomberg, Redington
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
%
30-Year Gilt Real Yield 30-Year Swap Real Yield Swap Spread (Swap Yield - Gilt Yield)
![Page 8: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/8.jpg)
Risk management Hedging CPI Swaps Pricing*
7 © 2010 The Actuarial Profession www.actuaries.org.uk
• 20 year RPI 3.475% - 3.575%
• (Mid – 3.525% and 5bp spread)
• 30 Year RPI 3.927% - 3.655%
• (Mid – 3.605% and 5bp spread)
• Vs
• 20 year CPI 2.852% - 3.252%
• (Mid – 3.052% and 20bp spread)
• 30 Year CPI 2.927% - 3.327%
• (Mid – 3.127% and 20bp spread)
RPI/CPI spread
• 20 year CPI Mid – 3.052% and 20 year RPI
Mid – 3.525%
• = -0.473% with at least 20bps spread.
• 30 year CPI Mid – 3.127% and 30 year RPI
Mid – 3.605%
• = -0.478% with at least 20bps spread.
Source: RBS
![Page 9: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/9.jpg)
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
![Page 10: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/10.jpg)
Risk management Alternative Sources of CPI
9 © 2010 The Actuarial Profession www.actuaries.org.uk
-6
-4
-2
0
2
4
6
8
0 5 10 15 20 25 30
GB
P M
illi
on
s
Years
Initial investment
Attractive real returns
Inflation-linked cashflows
Providing a match for liabilities
Inflows
Outflows
Source: Redington
Flight Plan Consistent Asset – Example Cashflow Profile
![Page 11: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/11.jpg)
Risk management Alternative Sources of CPI
10 © 2010 The Actuarial Profession www.actuaries.org.uk
Source: Evolution Securities, Redington
Most Risk Least Risk
Inherent
Sector Risk
Pricing
Mechanism
Satellites Generation
Ports
Environmental Renewables Airports
Storage Pipelines
Distribution Masts
Water Transmission
Bridges/Tunnels Rail
Defence Roads Transport
Education Healthcare
Social Housing
![Page 12: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/12.jpg)
11
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 2011
Forecast Q4 2011
Longevit y Swaps
Pension Insurance buy-out
Development of the insurance market for pensions in the UK since 2004
Source: PC analysis, LCP Buyout Report 2010, Hymans Robertson 2010 and H1 2011
Update
1) 2009 figures include £1.9bn RSA longevity transaction completed in July 2009
![Page 13: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/13.jpg)
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
12 © 2010 The Actuarial Profession www.actuaries.org.uk
![Page 14: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/14.jpg)
Pension scheme view of CPI vs. RPI
13 © 2010 The Actuarial Profession www.actuaries.org.uk
![Page 15: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/15.jpg)
Expectations of RPI to CPI gap
14
Party / Source RPI-CPI assumption
The Office for Budget Responsibility, Economic and
Fiscal outlook of March 2011
1.2%
FTSE350 Pension Fund accounting disclosures,
Hymans Robertson’s 2011 survey
0.7% to 2.8%
Mercer briefing July 2011 0.5% to 0.8%
Investment Bank instruments 0.1% to 0.2%
Our survey See later slides
![Page 16: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/16.jpg)
Insurer view of CPI vs. RPI
15 © 2010 The Actuarial Profession www.actuaries.org.uk
![Page 17: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/17.jpg)
RPI v CPI: Historic differences
• The average annual RPI-CPI gap from May 1997 to July 2011 was 0.88%
• Annualised standard deviation of monthly observed RPI-CPI basis was
1.27%
• RPI was above CPI for 85% of the period
– Main period of negative RPI-CPI due to rapid mortgage cost inflation
reduction over 2008
16
![Page 18: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/18.jpg)
RPI v CPI density function
17
Histogram of RPI-CPI since May 1997 and approximated density function
Abnormal – e.g. falling interest rates
mean of – 2.9% (CPI higher)
Normal : mean of 1.1%
(RPI higher)
![Page 19: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/19.jpg)
RPI vs. CPI – stochastic simulation – no underpin
18 © 2010 The Actuarial Profession www.actuaries.org.uk
Source: Barrie and Hibbert
![Page 20: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/20.jpg)
RPI vs. CPI – stochastic simulation – with underpin!
19 © 2010 The Actuarial Profession www.actuaries.org.uk
Source: Barrie and Hibbert
![Page 21: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/21.jpg)
CPI, RPI and base rates
20 © 2010 The Actuarial Profession www.actuaries.org.uk
![Page 22: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/22.jpg)
Hedge with RPI – implications for insurers
• 1 in 200 year test – capital requirements
– statistical variation
– changes in the basket of goods
– changes in calculation methodology
– political influence
• Shock effects if CPI market develops differently
• Impact of caps and floors:
– Volatility of CPI is lower than RPI
– So floor and cap both less likely to bite? Net impact?
21 © 2010 The Actuarial Profession www.actuaries.org.uk
![Page 23: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/23.jpg)
Hedge with CPI
22 © 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
![Page 24: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/24.jpg)
Insurer solutions
• Insure on CPI but small discount to RPI
– Benefits indexed to CPI
– Expected CPI under-run
– Offset by cost of risk capital
• Option 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?
23 © 2010 The Actuarial Profession www.actuaries.org.uk
![Page 25: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/25.jpg)
But general market movements more significant
24 © 2010 The Actuarial Profession www.actuaries.org.uk
• Chart shows ‘overall affordability’ for a scheme with a blend of deferred and pensioner liabilities, and
invested in a 55% equities / 45% bonds mix. ‘Affordability’ considers the cost of insuring the pension
risk compared to the value of the assets held by the scheme. A higher value in the index means that
insurance is more affordable for pension schemes (insurance costs have fallen and / or asset values
have risen)
• Bulk annuity affordability plunged during the second half of 2011, primarily due to ultra-low Gilt yields,
but equities also dragged down funding positions
50.0
55.0
60.0
65.0
70.0
75.0
80.0
Fundin
g level in
% Affordability
![Page 26: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/26.jpg)
Redington – Pension Corporation Survey 112 Actuaries and Trustees between May and October 2011
25 © 2010 The Actuarial Profession www.actuaries.org.uk
• Overwhelming majority of schemes vulnerable to future
inflation increases
• Less than 20% of defined benefit pension schemes surveyed
had at least 50% of their inflation-linked pensions backed with
inflation-linked assets such as index-linked gilts
• General inflation risk a much greater risk to most schemes
than CPI/RPI basis risk
Key Findings / Conclusions
![Page 27: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/27.jpg)
Our survey says...
© 2010 The Actuarial Profession www.actuaries.org.uk
![Page 28: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/28.jpg)
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:
27 © 2010 The Actuarial Profession www.actuaries.org.uk
Based on responses from 88 Actuaries
and 13 Trustees
0%
10%
20%
30%
40%
50%
60%
70%
0% - 25% 25% - 50% 50% - 75% 75% - 100%
Proportion of matching assets
Actuaries Trustees
![Page 29: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/29.jpg)
Survey Results
2. To Trustees: Does your scheme specify statutory
minimum revaluation / indexation, i.e. could the scheme
automatically move to CPI?
28 © 2010 The Actuarial Profession www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Yes No
"Statutory minimum" specified
Revaluation in deferment Benefit indexation in payment
Based on responses from 21 trustees
![Page 30: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/30.jpg)
Survey Results
3. To Trustees: Will your scheme move to CPI (rather than
retain RPI):
29 © 2010 The Actuarial Profession www.actuaries.org.uk
Based on responses from 20 trustees
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Yes No
Proportion of schemes
Revaluation in deferment Benefit indexation in payment
![Page 31: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/31.jpg)
Survey Results
4. In your view is it fair that schemes that can move to CPI
should move to CPI?
30 © 2010 The Actuarial Profession www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
70%
80%
Yes No
Actuaries
Trustees
Based on responses from 85 Actuaries
and 23 Trustees
![Page 32: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/32.jpg)
Survey Results
5. What is your long term expectation for CPI inflation
relative to RPI inflation:
31 © 2010 The Actuarial Profession www.actuaries.org.uk
0% 10% 20% 30% 40% 50% 60% 70% 80%
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
Actuaries Trustees
Based on responses from 89 Actuaries
and 23 Trustees
![Page 33: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/33.jpg)
Survey Results
6. Of possible de-risking options, which of the following do
you think your schemes consider seriously over the next
3 years:
32 © 2010 The Actuarial Profession www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
Unlikely Likely Almost certainly
a. Liability Management Exercise
Actuaries
Trustees
Based on responses from 87 Actuaries
and 22 Trustees
![Page 34: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/34.jpg)
Survey Results
6. Of possible de-risking options, which of the following do
you think your schemes consider seriously over the next
3 years:
33 © 2010 The Actuarial Profession www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Unlikely Likely Almost certainly
b. Longevity Swap
Actuaries
Trustees
Based on responses from 86 Actuaries
and 21 Trustees
![Page 35: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/35.jpg)
Survey Results
6. Of possible de-risking options, which of the following do
you think your schemes consider seriously over the next
3 years:
34 © 2010 The Actuarial Profession www.actuaries.org.uk
0%
10%
20%
30%
40%
50%
60%
70%
Unlikely Likely Almost certainly
c. Buy-in/Buy-out
Actuaries
Trustees
Based on responses from 87 Actuaries
and 23 Trustees
![Page 36: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/36.jpg)
Survey Results
35 © 2010 The Actuarial Profession www.actuaries.org.uk
d. Other:
“Journey planning / flight path / de-risking triggers”
“Phased buy-in, via annuity purchase when members retire”
“Closing to future accrual (for those few schemes still open)”
“Increase in LDI assets”
“Winding up”
“More bonds”
6. Of possible de-risking options, which of the following do
you think your schemes consider seriously over the next
3 years:
![Page 37: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/37.jpg)
Survey Results
36 © 2010 The Actuarial Profession www.actuaries.org.uk
7. What impact has the CPI move had on schemes
considering de-risking?
“Little / None”
“Potential reduction in Buy-out cost. Slightly more scope to exchange
pension increases. Some offset CPI gains through lower risk investment
strategy”
“Caused delays to some looking at buy-in/out because insurers have
been unable to provide CPI pricing”
“As far as I am aware [public sector schemes] are not looking to derisk,
other than via wholesale benefit changes following Huttons report”
![Page 38: Investment Implications of RPI to CPI](https://reader034.fdocuments.us/reader034/viewer/2022051413/558535a6d8b42a3a308b5231/html5/thumbnails/38.jpg)
Questions or comments?
37 © 2010 The Actuarial Profession www.actuaries.org.uk
David Collinson
• Co-Head of Business Origination
• Pension Corporation
• Tel: + 44 20 7105 2110
Robert Gardner
• Co-Chief Executive
• Redington
• Tel: + 44 20 7250 3416
In addition...
http://twitter.com/robertjgardner
http://uk.linkedin.com/in/robertjgardner