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Overview

In the June 2010 Budget, the Government announced that, with effect from April 2011, the Consumer Prices Index (“CPI”) will be used instead of the Retail Prices Index (“RPI”) for determining pension increases for public sector schemes.

The Pensions Minister, Steve Webb, subsequently issued a statement confirming that the Government also intends to use the CPI instead of the RPI to calculate increases and revaluation of deferred benefits in private sector final salary schemes. The CPI will also be used to increase Guaranteed Minimum Pensions and compensation paid by the Pension Protection Fund and the Financial Assistance Scheme.

A second statement was issued by the Department for Work and Pensions on 12 July to clarify the proposals. This confirms that a “statutory minimum requirement” will continue to apply to the revaluation and indexation of pension benefits (although the amount is not specified), and that the changes will apply to final salary rights and to certain money purchase rights in occupational schemes.

Why the CPI?

The RPI is intended to provide a general measure of prices across all household spending. In contrast, the CPI does not include housing costs or Council Tax. The Government therefore considers that the CPI provides a better index of inflation for pensioners.

The CPI has generally increased at a lower rate than the RPI, so over time this could have a detrimental effect on members’ benefits but a beneficial effect on a scheme’s funding position. Some commentators have calculated that the change to the CPI could wipe 10% off private sector final salary scheme liabilities.

Implementing the Legislation

A revaluation order is made each year which sets out the minimum rate at which occupational pension schemes should revalue deferred benefits and increase pensions in payment. The order uses data on price inflation up to 30 September of the previous year. The July statement confirms that the order which will be in use in 2011 will use data on price inflation to the year ending 30 September 2010 based on the CPI.

The Government expects to publish the 2011 order in November or December 2010. It also intends to bring forward legislation at the earliest opportunity to ensure that other references in pensions law are consistent with using the CPI.

The July statement gives some illustrative examples of how the change to the CPI might work in practice. Although these are specified to affect future revaluation and indexation calculations only, they appear to provide for an automatic change to the CPI for existing deferred members and pensioners currently receiving benefits calculated by reference to the RPI. Given the constraints of section 67 of the Pensions Act 1995 which prevents detrimental amendments to members’ accrued rights and any fetters on a scheme’s amendment power, any change to the CPI will generally only be possible for increases or benefits provided in respect of future pensionable service completed after April 2011.

It is, therefore, unclear how the Government intends to permit an automatic change to the CPI for existing pensioners and deferred members (if this is in fact what is intended).

Changes to Scheme Rules

Many final salary scheme rules require the RPI to be used to calculate pension increases and revaluation of deferred benefits. The required rate has changed over recent years. Since 6 April 2005, schemes have been able to reduce the rate of pension increases from the lower of 5% per annum or the RPI to the lower of 2.5% per annum or the RPI, and since 6 April 2009, schemes have been able to reduce the rate of revaluation of deferred benefits in a similar manner. In both cases, any change can only apply to increases or benefits provided in respect of pensionable service completed after the relevant provisions came into force.

If scheme rules require the RPI to be used, they will need to be amended before any increases or revaluation can be calculated by reference to the CPI. As noted above, because of section 67, unless the Government makes substantive amendments to pensions legislation, our view is that any change to the CPI will only be able to operate for benefits accrued in respect of future pensionable service after April 2011. Additionally, it will be necessary to consider the terms of the scheme’s amendment power, as this may contain fetters preventing detrimental amendments to members’ accrued rights, and may also require the trustees’ consent.

Some schemes provide fixed rates of revaluation and indexation. It is not clear how these will be affected by the change to CPI.

Comment

Although some industry bodies and employers have welcomed the announcement in the light of the potential significant reduction for scheme deficits, other organisations have expressed concerns about the potential detrimental effect on some members’ benefits.

We advise trustees and employers to adopt a “wait and see” approach, pending further clarification and draft legislation. In particular, it is not clear from the July statement how the Government intends to achieve an automatic change to the CPI for existing pensioners and deferred members.

When the position has been clarified, schemes will need to consider whether to adopt the migration to the CPI or to retain the more generous RPI. Scheme rules will need to be reviewed to understand the impact of any changes and to be amended if necessary.

For more information please contact David Hosford, Symon Rowley or Rosamund Lee, or any member of Pitmans’ Pensions Department.

David Hosford – Partner
Email: dhosford@pitmans.com
Direct Dial: 0118 957 0363

Symon Rowley – Director
Email: srowley@pitmans.com
Direct Dial: 0118 957 0301

Rosamund Lee – Solicitor
Email: rlee@pitmans.com
Direct Dial: 0118 957 0261