CPI - the story so far

In 2010 the Government announced its decision to change the statutory minimum basis for calculating annual increases to pensions in payment (indexation) and revaluing deferred pensions (revaluation) to reflect changes in the Consumer Price Index (CPI) rather than the Retail Price Index (RPI). The change was primarily introduced to public service pension schemes, but also extends to private sector salary-related occupational pension schemes.

The change of policy has required amendments to both primary and secondary legislation. The main vehicle for implementing the change has been the annual revaluation orders made by the Department for Work & Pensions, which cover both the indexation and revaluation mechanisms and have been based on CPI since 1 January 2012. Changes to primary legislation have also been enacted by the Pensions Act 2011 and came into force on 3 January 2012.

Additionally, a number of consequential changes have been made. For example indexation of compensation in payment from the Financial Assistance Scheme (FAS) and Pension Protection Fund (PPF) will now be with reference to CPI instead of RPI, and accruals of benefits in FAS qualifying schemes and deferred compensation payable from the PPF must be revalued with reference to CPI. The FAS compensation cap also increases with reference to CPI.

However, no overriding or modifying statutory power has been introduced allowing schemes to automatically switch to CPI-linked indexation or revaluation. Therefore, a formal amendment to the scheme rules may be required. If rule amendments are required, the employers and trustees must consider whether there are any restrictions in the amendment powers or under s 67 of the Pensions Act 1995 that might prevent the change.

Power in the rules

In Danks v Qinetiq Holdings Ltd [2012] EWHC 570 (Ch) the trustees wished to adopt CPI in an effort to reduce a substantial deficit. This was challenged on the basis that it would adversely affect subsisting rights of members and was therefore voidable under s 67 of the Pensions Act 1995.

An argument that RPI was the default rate when the pensionable service was undertaken and therefore remained the appropriate rate was rejected. It was held that there was no right for indexation to be at a particular rate, as the scheme rules allowed for RPI-linked indexation or an alternative. A member’s right to revaluation was not an accrued right until the revaluation calculation had been done. Therefore the exercise of the trustees’ power to adopt CPI at or prior to the date of indexation or revaluation was not a detrimental modification and did not fall foul of s 67. On a true construction of the trust deed and rules it was possible to have a different cost of living index for different purposes under the scheme.

The decision indicates a willingness to look at the true construction of scheme rules, rather than adopting a strict adherence to the words on the page. This will be of interest to sponsoring employers and trustees of occupational pension schemes who are considering the move to CPI-linked revaluation or indexation or both, which studies have shown may have a considerable impact on the scheme’s funding position. However, given the potential effect on members’ expectations, resistance from members should be expected, a key consideration for trustees in negotiations with the employer.

Public service

The Government’s decision to switch to CPI-linked indexation in public service pensions schemes was declared to be lawful in the judgment handed down in R (FDA and others) v Secretary of State for Work and Pensions [2012] EWCA Civ 332. The Court of Appeal was unanimous in dismissing the appeal, which challenged the making of the Social Security Benefits Up-Rating Order 2011 and the Pensions Increase (Review) Order 2011. These set out that the level of increases granted to certain benefits would be calculated on the basis of CPI as opposed to RPI. There is to be no appeal to the Supreme Court.

Proper information

If a decision to switch to CPI-linked indexation or revaluation or both is made, correspondence with members communicating the change should clearly explain the reasons for the change and make clear the likely effect on members’ benefits. Employers of 50 or more employees should also be aware that the Occupational and Personal Pension Scheme (Consultation by Employers and Miscellaneous Amendment) Regulations 2006 have been amended with effect from 6 April 2012, so that a switch to CPI-linked indexation or revaluation will constitute a “listed change” requiring consultation by employers with affected active and prospective members of the scheme. Proposals to change to CPI which were communicated to affected members prior to 6 April 2012 are unaffected.