Indexation: importance of scheme-specific provisions

A recent Pensions Ombudsman determination (Mr S, PO-21607) provides a timely reminder that, when considering the measure of price inflation to use for increasing pensions, the exact wording of the scheme rules and the process followed prior to any change are, for the time being, paramount.

The scheme rules in this case are provided as follows: 

The Second Definitive Trust Deed and Rules, 31 August 1989

A pension in payment to a Pensioner on 31st March will be increased on the following 1st November at the lesser of:

1. the rate of increase in the Index (as defined in General Rule 25) published in the April prior to the 1st November concerned over the level of the Index published in the preceding April, and 
2. a rate of three per cent.

Index is defined as: the Index of Retail Prices published by the Department of Employment or any other official cost-of-living selected by the Trustee Company and approved by the Board of Inland Revenue.

The Scheme’s Definitive Trust Deed and Rules, dated 27 May 2005

…the rate of increase of pension in excess of GMP shall not be less than 5% (or the increase in the Retail Price Index, if less)…

Index means the Index of Retail Prices published by the Central Statistical Office of the Chancellor of the Exchequer or any index which is accepted by the Commissioners of Inland Revenue for this purpose.

The scheme employer approached the trustee and asked them about using the Consumer Price Index (CPI) in place of the Retail Price Index (RPI) as the reference index for increasing pensions in payment. After obtaining legal and actuarial advice, the trustee concluded that CPI was a more appropriate inflation index for determining future pension increases and that it was possible to use CPI rather than RPI under the scheme rules.

Mr S unsuccessfully complained about the index change via the scheme’s internal dispute resolution procedures and so took his complaint to the Ombudsman.

Dismissing his complaint, the Ombudsman said:

While I can understand Mr S’ concerns at the change from RPI to CPI I do not find that [the trustee] has approached this subject in anything other than a professional manner. [The trustee] has obtained appropriate legal and actuarial advice over the change, which included advice on the legal factors that should be taken into account … . [The trustee] also obtained actuarial advice, prior to the actuarial valuation, on what would happen if Sappi [the principal employer] withdrew its support for the Scheme and this advice was included in the formal response to the complaint. The formal response also confirmed that since the 2017 actuarial valuation has been signed off  changes have been made to improve the guarantee from Sappi.

The Ombudsman noted that the trustee “has also stated that it wishes to move towards a self-sufficiency funding target and the adoption of CPI will improve the funding position towards the self-sufficiency target and give greater security to all the members”.

The Ombudsman also considered the employer’s earlier decision to move to a sole corporate trustee and held that this was within the principal employer’s remit. The trustee was independent and had a duty to act in the best interest of all the members. Before agreeing to the employer’s request to change the measure used for increasing pensions, the trustee considered the correct scheme provisions, took professional and expert legal and actuarial advice, and ultimately reached a decision that was not perverse.

Comment

Since 2011, when the Government changed the measure of price inflation for pension increases from RPI to CPI for State and public service pensions, there have been numerous determinations and other cases on introducing a different measure in private sector schemes. All have turned on their own facts but, and this is why this determination is timely, the current situation (often referred to a ‘scheme rules lottery’ may change by around the middle of this decade.

The reason for this is that RPI is expected to align with CPIH, a variant of CPI introduced in 2013 which includes an allowance for owner occupiers’ housing costs (OOH). The proposed change is due to happen sometime between 2025 and 2030. This follows a Lords’ Committee report on inflation published in 2019, that highlighted what has been known for some time: the RPI formulae has a number of known errors in it, and the ONS believes CPIH is a better measure of inflation. What is unclear at present is the timing for such a change and what compensation if any holders of index linked gilts will receive for the expected reduction in future payments. These questions are expected to be answered following two consultations being launched on 11 March 2020, along with the Spring Statement, the outcomes of which are expected before the summer recess. 

Once the change has occurred, schemes that have RPI hard-coded in their rules can expect to pay out lower pension increases in future, and hence smaller pensions, than they would otherwise have done. Similarly, whilst less of an issue, schemes that revalue deferred members’ benefits in line with RPI can also expect to pay out smaller pensions in the future than they would otherwise have done. Current deferred pensioners could, therefore, be subject to both lower revaluation in deferment and lower pension increases in payment. However, it will also mean schemes that hold index-linked gilts and other assets whose return is linked to RPI will see a fall in the value of their assets (subject to any compensation being given).

Therefore, it should be stressed that this does not mean that there will be an automatic improvement in the scheme funding position for all defined benefits schemes; it will depend on the assets and liabilities of each scheme (e.g. any ‘hedging’ arrangements) and so, in this sense, there will still be a bit of a ‘lottery’, albeit quite different from the current one.