The High Court has given judgment in the Prudential case concerning a decision to change the basis of future pension increases. Prudential succeeded in its argument that it was entitled to act in its own interests, and not those of the pensioners, when considering the level of annual pension increases.

The scheme rules required only statutory pensions increases but included an augmentation rule which allowed Prudential to determine whether (and on what basis) additional benefits should be paid.

The scheme had a long history of awarding inflation-linked pension increases in excess of statutory requirements. The Court found that there was a general understanding amongst members that, except when inflation had been particularly high in the 1970s, pensions increases had fully kept pace with inflation and that that pattern would continue – but Prudential was not thought by the members to have guaranteed or committed itself to those increases.

In 2005 the scheme actuary reported a £1bn deficit. After much coming and going, the Trustees agreed to a proposal that increases should be capped at 2.5 per cent LPI (the statutory minimum). The proposals also included deficit reduction contributions from Prudential of £35m per annum for 10 years.

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The members argued that Prudential had breached its duty of good faith in adopting the 2.5 per cent LPI cap and in the manner in which it applied the new policy. The judge (Mr Justice Newey) quoted the classic statement of good faith from the Imperial case:

“Employers will not, without reasonable and proper cause, conduct themselves in a manner calculated or likely to destroy or seriously damage the relationship of confidence and trust between employer and employee...the relevant question is not whether the company is acting reasonably...It must be open to the company to look after its own interests, financially and otherwise, in the future operations of the scheme.”

Newey J concluded that the power to exercise the discretion to award pension increase was not fiduciary – this meant that the Prudential was entitled to have regard to its own interests. The question was whether, overall, the decision was irrational or perverse. He found that a breach of the obligation of good faith requires conduct of “some seriousness” – an irrational decision on a trivial matter might well not be enough to breach the obligation. One key conclusion was that the “very strong expectations of members” did not make Prudential’s decision irrational nor did the manner in which the decision was communicated to members affect its validity. Prudential was entitled to have regard to its own interests – the scheme’s financial state had deteriorated and it had undertaken to make additional contributions as part of the decision to limit pension increases.