PensionsApr 7 2017

Pension scheme revaluation - when to switch?

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Pension scheme revaluation - when to switch?

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 judge observed that under the scheme rules, the principal employer could not alter any of the members’ benefits without the trustees’ consent.

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.

The parties accepted that CPI was a “similar” index to RPI and this point was not, therefore, considered further. Equally, HMRC had confirmed that CPI is a satisfactory measure for the purpose of indexation.

The court did, however, consider if CPI could be regarded as “satisfactory for the purposes of HMRC” in respect of revaluation. The judge found that “…an index must be regarded as ‘satisfactory for the purposes of [HMRC]’ if there are no grounds on which HMRC could properly or reasonably consider it other than satisfactory for their purposes.

"Given that (a) pension schemes are no longer approved by HMRC…(b) CPI has received government endorsement and is now used for statutory revaluation of pensions and (c) the use of CPI…should not be in any way prejudicial to HMRC…”.

CPI did satisfy the criteria for pension increase purposes. Newey J did, however, go on to note that “the position could…change…if…the statutory framework relating to pensions were altered…”.

It was held that pension increases were determined by reference to the Retail Prices Index, which in turn was defined as “the General Index of Retail Prices.

Who has the power to choose which index applies where the rules do not specify one? Some rules, as in the Arcadia case, do not stipulate who has the power to determine which index applies. In Arcadia, the high court considered the rules of the scheme as a whole.

The judge observed that under the scheme rules, the principal employer could not alter any of the members’ benefits without the trustees’ consent.

He went on to say that the trustees “…can be seen as natural spokesmen for the scheme…[which] suggest[s] that they were intended to be involved in any exercise of the power of selection”.

The power of selection was, therefore, held to be vested in the principal employer and the trustees jointly.

Replacements?

Can CPI be used instead of RPI if the rules provide that either RPI is to be used “…or a replacement adopted by the Trustees"?

In Buckinghamshire and others v Barnardo’s and others [2015] (Barnardo’s), the rules provided that, broadly, indexation and revaluation should be increased using the 'prescribed rate', which was defined as the lesser of 5 per cent and 'the percentage rise in the Retail Prices Index (if any)'.

'Retail Prices Index' was defined as the 'General Index of Retail Prices' or any replacement adopted by the Trustees without prejudicing Approval  A second sentence expanded this definition and referred to the “replacement or re-basing” of the Retail Prices Index.

The high court held that the scheme rules did not give the trustees the power to switch from RPI to CPI for revaluation or indexation, so long as RPI remained an officially published index.

In November 2016, the court of appeal upheld the first instance decision, but the decision was not unanimous. It was held that pension increases were determined by reference to the Retail Prices Index, which in turn was defined as “the General Index of Retail Prices…or a replacement adopted by the Trustees without prejudicing approval.”

The majority decision held that the natural meaning of the first part of the definition was that a “replacement” of the RPI had to precede the adoption of any such replacement by the trustees. The second sentence, referring to replacement and re-basement of the RPI, was helpful in interpreting the first sentence of that definition.

The RPI can only be “re-based” by the authority responsible for publishing it. As the terms “replacing” and “rebasing” were used together in the second sentence, the same person had to carry out both the “replacing” and the “rebasing”.

The term “replacing” had the same meaning in both the first and second parts of the definition. It followed that any “replacing” could only be carried out by the authority responsible for publishing the RPI and that, without its official replacement, there was no other “replacement” which the trustees could adopt instead.

Can CPI be used instead of RPI if the rules provide that either RPI is to be used "or a replacement adopted by the Trustees"? This is an alternative approach.

The dissenting judgment in the court of appeal in Barnardo’s took a different approach to the interpretation of the definition of the RPI. While “rebasing” could only be carried out by the publishing authority, “replacing” could be carried out either by that authority or by the trustees.

The use of both terms together did not necessarily mean that they were both to occur as a result of the actions of the same entity.

The preferred interpretation was that the definition should be read to mean that “Retail Prices Index” could be the Index of Retail Prices or any replacement which is adopted by the trustees. 

What next?

Many schemes were interested in adopting CPI as a means of reducing scheme liabilities as it (to date) has often produced a lower uplift to benefits than RPI. The ability of schemes to use CPI instead of RPI depends upon the precise wording of the rules.

Many schemes’ revaluation provisions are drafted in terms of reference to the relevant legislative provisions and where this is the case, amendments will not be required. However, in some cases the rules may refer specifically to RPI.

Where rule amendments are required to adopt CPI, any restrictions in the scheme’s power of amendment will need to be taken into account, and CPI-based increases.

Julia Ward is associate and is Lesley Browning is partner in the pensions team at global law firm Norton Rose Fulbright