In order to assess long-term DB liabilities, some estimate of inflation is crucial. In the UK, the RPI used to matter, not the CPI or CPIH. With effect from April 2011, the public service pension scheme increases were switched from RPI to CPI, which some private sector pension schemes were able to follow.
Not only are preserved benefits normally partially linked to inflation over the whole deferment period, but also pensions in payment are partially linked to inflation on a year-by-year basis. Some pension schemes grant full RPI coverage whereas others have a 5% limit (few schemes appear to have adopted the 2.5% limit permitted since 2005). Even for a lower limit, one still needs some idea of how much the full increase would be and how much to allow as a margin.
Index Annual Increases Since January 1989
RPI peaked at 10.9 % pa in the year until October 1990 with a trough of minus 1.6% pa in the year until June 2009 (April 2015).
CPI peaked at 8.5 % pa in the year until April 1991 with a trough of minus 0.2% pa in the year until April 2015.
CPIH peaked at 9.2 % pa in the year until October 1990 with a trough of 0.2% pa in the year until October 2015. Unlike RPI and CPI, CPIH increases have always been positive.
Relative Annual Increases Since January 1989
RPI v CPI On average, RPI exceeded CPI by 0.7 % pa, with a minimum of minus 3.5 % pa (April 2009) and a maximum of 3.1 % pa (July 1990).
RPI v CPIH On average, RPI exceeded CPIH by 0.6 % pa, with a minimum of minus 3.4 % pa (April 2009) and a maximum of 2.6 % pa (June 2010).
CPIH v CPI On average, CPIH exceeded CPI by 0.1 % pa, with a minimum of minus 1.0 % pa (July 1991) and a maximum of 1.7 % pa (January 1991).
The figures immediately above do not show that there have been changes over time, which can be more easily seen from the charts.
Although UK inflation has hardly been above 5% in any year since the early 1990s, that has simply not always been the case, with some of us recalling the 1970s. Why should we assume that it must remain under control? Yes, the Bank of England has a remit to keep inflation under control but that is currently based upon the CPI rather than the RPI and they could still fail in that mission. Increases comparison charts for and between CPI, CPIH and RPI are shown, linked from RPI alone (since 1953), RPI and CPI (since 1975) and all three (since 1989).
We're worried that liabilities are being hugely overstated, by the order of at least 25%, possibly even higher. While we don't claim to know the future, some estimate must be made and we are worried that current estimates are just plain excessive. Oh, no, we don't believe there is a holy grail. Further, we are surprised that major UK actuarial consultancies can assume a long-term average increase difference as high as 1% pa between CPI and RPI. While we have seen that in single years, we have rarely seen it over periods as long as 10 years (6 out of 44 between 1975 and 2019) and never over periods as long as 15 years.
Suppose we compare RPI with “CPI+X” for statistical significance (one-tailed 5%) over time. Using a t-test, we found that X = 0.90% is significantly different (0.89% is not significant). Over the whole period since CPIH started being published, we have concluded that it is not statistically different from CPI.