Pension increases in defined benefit schemes have become increasingly complex and contentious, not least because of the significant funding costs they involve. The recent decision in Dutton v. FDR Limited EWHC 2946 (Ch) highlights a problem that may well exist in many other pension schemes.
The FDR Limited Pension Scheme (the Scheme) originally provided fixed pension increases of 3% per annum. In June 1991 the Scheme was amended to provide increases at the lower of LPI/5% per annum. The change was prompted by two factors:
- the Social Security Act 1990, which provided for increases at the lower of LPI/5% (this was never brought into force and was replaced by the Pension Act 1995, which brought LPI/5% increases into force on 6 April 1997); and
- inflation had been very high since the early 1970s and consistently well above 5% so it was considered the change would give members 5% increases in practice.
In several of the years since the change in 1991 inflation dipped below 3% and in 2009 it was negative. Questions arose as to whether the change from fixed 3% increases to LPI/5% was valid.
The power of amendment in the Scheme as at 1991 prohibited amendments that prejudicially affected (a) any pension in payment at the date of the change or (b) rights or interests that had accrued to any member up to the date of the change. Both the Trustees and the Employer accepted that the 1991 amendment was valid insofar as it operated prospectively after June 1991. It was not in issue that the 1991 amendment breached the restrictions in the power of amendment and that the right to fixed 3% increases could not be removed as the LPI/5% increase rule could lead to increases of less than 3%. The only issue was how the two increase rules should operate together. The Trustees' case was that annual increases should be the greater of 3% and LPI/5%. The Employer suggested a less expensive approach for pre-June 1991 pension/accrued rights requiring two separate records of increases and labelled as the modified cumulative approach. This involves taking the higher of the value of (i) a member's pension at retirement increased annually by 3% including the year in which the increase is to take effect and (ii) the pension increased annually by LPI/5% including the year in which the increase is to take effect subject to a floor of 0%. The potential increase in the Scheme liabilities was between £5 million and £17 million on a technical provisions basis depending on the approach adopted.
Asplin J held that the annual approach contended for by the Trustees should be adopted because:
- it was the most natural meaning to apply to the wording of the two pension increase rules;
- it avoided unnecessary technicalities such as keeping separate records of increases;
- it would have been easy to work in 1991 when the change was made whilst the alternative would have been expensive and would have required different percentage increases for different members; and
- the cumulative approach was an uncommon approach.
This decision turned on the construction of the rules of the Scheme and it seems a straightforward decision. However, it is, perhaps, indicative of a problem many older pension schemes may not appreciate they have on pension increases. The FDR Pension Scheme was set up in the early 1970s and the fixed 3% increase rule was probably derived from "value for money" provisions under the Social Security Act 1973, which were repealed in 1985. One option under these provisions was to provide 3% annual pension increases. Schemes dating from the 1970s or earlier may need to look at the history of their pension increase rule to ensure they do not have a similar problem. The issue could arise either because of an amendment (as in this case) or because of the introduction of the statutory requirement to provide pension increases at the lesser of LPI/5% on 6 April 1997 where this may have been applied in preference to the earlier pension increase rule.
The Employer's case was complex and, as noted above, it depended on two separate records being kept of pension increases and would have required detailed calculations on increases for each member. A member's individual history of past increases would have been relevant so that the percentage increase (if any) for each member would have been different. Whilst it may be possible to adopt such an approach today, at the time the amendment was made in 1991 it would have required manual calculation and would have been prone to human error. It is very unlikely that this would have been the intention at that time. The decision has a significant financial impact for the Employer and it is possible it may appeal. Should it do so it may well question the line of cases beginning with Re Courage Group's Pension Scheme  dealing with restrictions on powers of amendment.