Inflation-Adjustment is now mandatory for pensions KFIs. But should it be extended to annuities, income drawdown illustrations and TVA reports?
15 April 2014
The FSA’s PS13/2, published way back in March 2013, finally came into effect earlier this monthwhich means that new personal pensions Key Features Illustrations (KFIs) must show inflation-adjusted growth figures and use new projection rates of 2, 5, and 8%. Effect of charges and Reduction in Yield information must now be based on the new, lower intermediate rate of 5%. However inflation-adjustment is not mandated for Transfer Value Analysis (TVA) reports, income drawdown or annuity illustrations yet. That said, the Financial Services Consumer Panel response to this change, went further to advocate extending real term projections into TVA reports, annuities and income drawdown illustrations to create a level playing field and extend the principle of transparency. Naturally in the industry itself, there were loud objections to moving to inflation-adjustment for new KFIs; not least is the fact that both ISA and GI products are still not be subject to the rule. This creates an uneven playing field which discriminates against personal pensions at a time when they are already under the cosh. Furthermore, the fact that with the new low flanking rate is 2% and the inflation adjustment percentage pushes figures down by 2.5% means that lots of new pensions policy holders will be seeing negative growth projection numbers on KFIs arriving on their doorstep. Then there is the question of what price inflation figure we should fix on. We can use inflation percentage based on RPI (Retail Price Index) or CPI (Consumer Prices Index). The Office of National Statistics is advocated CPI which is the measure which excludes costs related to the home (mortgage payments, rents, council tax rises etc.) and is generally agreed to be calculated using truer maths and as such reflects the inflation that most of us experience. It is also lower, on average 1.2% lower over the last 25 years, than RPI. The DWP has already declared that CPI is now the ‘inflation index of choice’ for statutory minimum revaluation and indexation for occupational pension schemes and for relevant payments made by the Pension Protection Fund and the Financial Assistance Scheme. So are we to assume the same for the personal pensions world? The policy statement does not stipulate which seems an odd omission in that the impact of using RPI rather than CPI, if compounded over many years to a notional retirement date, could be well over 20%. That said it is logical that the industry would select the index which shows the lowest impact on your project pensions pot i.e. CPI. But is it all that clear cut, particularly if we are extending inflation-adjusted illustrations into decumulation on annuity and income drawdown illustrations? There is now substantial evidence that the inflation we experience varies along demographic and socio-economic lines. There are moves afoot to establish a Silver-CPI which reflects the over 54 year olds’ changing buying behaviour. Age UK is already advocating use of the ‘Silver RPI’ . The charity argues that older people are less exposed to the current low mortgage interest rate environment (they have often paid their mortgages off) but more exposed to current rises in food and utilities bills. Age UK give us a table which indicates that an average 65-69 year old faces an additional annual cost of £1,054 based on 2008-11, compared with standard RPI. Recent Dunstan Thomas-commissioned consumer research, found that many consumers simply don’t understand the impact of inflation-adjustment. Separate Money Advice Service (MAS) research published last August: https://www.moneyadviceservice.org.uk/en/static/new-study-shows-uk-developing-positive-money-habits also shows there is a good deal of education to do around this area before everyone fully grasps the array of numbers being provided to them in illustrations. One worrying statistic that came out of MAS’ Financial Capability of the UK Report was that 12% of UK consumers think that BoE base rate is currently set at over 10%! Perhaps we need to work harder to simplify illustrations as much as possible to communicate the key information they want and need on these important documents, rather than overlaying an already complicated mix of projection numbers with further layers of complexity. Should inflation-adjusted pension KFIs be extended across the board to TVA reports, annuities and income drawdown? Do we need to standardise on CPI for pensions illustration or give scope for application of a Silver-CPI for the over 55s, especially those in decumulation?