Pension scheme revaluation - when to switch?

Pension scheme revaluation - when to switch?

RPI and CPI – when can pension schemes switch for the purposes of revaluation and indexation?

Legislation requires that certain preserved benefits must be revalued to offset the effects of inflation between the date the member leaves service and the date he draws his pension, known as revaluation.

Pensioners’ pensions in payment are also required to be increased by a minimum amount each year, known as indexation.

Statute sets out minimum requirements for inflation proofing but does not stipulate how inflation is to be measured for the purposes of either revaluation or indexation.

Instead, the Secretary of State is required to make an annual order specifying the rate to be used and, historically, the index used was the Retail Price Index (RPI).

The Consumer Prices Index (CPI) was introduced in 1997, following the EU’s harmonisation of the existing index of consumer prices.

RPI and CPI each take into account a very different “basket of goods” and a different calculation in measuring inflation, with CPI often producing a lower figure.

Switch to CPI

From April 2011, the then government decided to switch to CPI rather than RPI to calculate increases in social security payments and public sector pension benefits. The switch from RPI- to CPI-based calculations was subsequently extended to the minimum statutory increases required for private sector pensions.

However, the government did not introduce an overriding or modifying statutory power allowing schemes to switch automatically to CPI-linked indexation or revaluation where RPI was “hard-wired” into the scheme rules.

This has caused challenges to pension schemes with rules where it is not clear whether the switch to RPI can be made. The remainder of this briefing looks at how the courts have to date interpreted various revaluation and increase rules.

Does a definition of RPI as “the government’s Index of Retail Prices or any similar index satisfactory for the purposes of HMRC” allow another index, such as CPI, to be used instead of RPI?

The cases demonstrate that whether the trustees have the power to use CPI instead of RPI for revaluation and/or indexation purposes depends upon the wording in the rules.

In Arcadia Group Ltd v Arcadia Group Pension Trust Ltd and another [2014] (Arcadia), the rules provided that the relevant measure of indexation was “Retail Prices Index [(or any replacement of that Index)]”. “Retail Prices Index” was in turn defined as “the government’s Index of Retail Prices or any similar index satisfactory for the purposes of HMRC.”

The high court found these rules allowed the trustees to choose an alternative index other than RPI. His main reasoning was as follows:

  • The definition of “Retail Prices Index” did not provide that a similar index could only be adopted if RPI itself was discontinued or replaced.
  • It was apparent there was some power of selection between indices. If, for example, RPI had been discontinued and HMRC suggested that either of two other indices would be appropriate, it could not be supposed that no one would have the power to choose between the indices.
  • The fact the label “Retail Prices Index” was used rather than a more neutral term was not determinative; it was clear from the definition of that expression the possibility of another index was provided for expressly.
  • Is CPI an index that is “similar” to RPI and “satisfactory for the purposes of HMRC?”

Depending on the wording of specific scheme rules, it may be that the trustees have the power to choose an alternative index, provided that alternative index is “similar” to RPI and/or “satisfactory for the purposes of HMRC”. The court in Arcadia considered whether CPI would satisfy these conditions.