Mind the Gap! Firstgroup cuts pensions by widening the CPI vs RPI gap

Back in 2011 when the government announced switching from RPI to CPI for determining public sector pensions we all should have known that this was just another ruse to use an even more unrepresentative inflation measure to cut expenditures. With the government’s lead it was also inevitable that this strategy would also be adopted by the private sector to do likewise.

Today’s interim results announcement by the struggling Firstgroup provides another example of how the widening gap between RPI and CPI assumptions can be used to cut real pensions for its employees, with a corresponding benefit for shareholders (albeit not a particularly fortunate bunch). Increasing the discount rate and reducing the inflation assumptions are positive in reducing the estimated size of a group’s balance sheet pension deficit. In Firstgroup’s case every +0.1% increase in the discount rate is estimated to be worth £32m with a similar reduction of -0.1% to inflation a further £27m.

For Firstgroup the below table from its H1 press release you can check out the changes in some of the assumptions being used. On a year on year basis, the discount rate was raised by +10bps, from 3.90% to 4.0% for the UK scheme (and by +50bps over the last 6 months). While the expected RPI rate has been trimmed by -5bps, from 3.0% to 2.95%, so to have the expected salary increases. The CPI assumption has been cut by double this rate and by -10bps from 1.95% to 1.85%, which has been matched by a similar -10bps reduction in assumed annual pension increases. The gap therefore between the real inflation rate which pensioners are expected to live in, as seen reflected in items such as the RPI and discount rate is widening versus their pensions which are being linked to the CPI which is heading the other way.

Benefit of squeezing CPI (& pension growth) further below RPI & the discount rate

For Firstgroup this has enabled them to cut their P&L pension charge (but not the cash outflows yet) by £22m in H1 FY16 (from £52.5m to £30.5m) and help cover up some of the underlying reversal in operating profits (of -£37m YoY before pensions). For the full year FY16, the group is forecasting that it now expects to deliver profits around +£15m higher than its previous guidance due to these pension assumption changes. However, assuming a similar rate of P&L cost benefit in H2, that would suggest an underlying contraction in FY16 guidance before this of almost £30m (£22m x 2 = £44m minus £15m = -£29m).

Just as well, they still give out free bus passes to pensioners in the UK!