It has been proposed by the Government that private sector (as well as public sector) pension schemes should be allowed to use the Consumer Prices Index (CPI) as opposed to the Retail Prices Index (RPI) as the measure of price inflation when applying increases to pensions in payment and when revaluing deferred benefits. The Government has stated that it believes this change will make pension benefits more affordable for employers.
Many commentators have pointed out that CPI is generally likely to be lower than RPI – for September 2010 the annual CPI rate was 3.1%, whereas RPI was 4.6%.
However, what these changes will mean for individual pension schemes will depend on how these proposals are ultimately translated into law. This uncertainty has largely been caused by the fact that different pension scheme rules will have reflected the requirement to apply increases or revaluation in different ways. Indeed, in Reed Smith’s experience, no two pension schemes will have provisions worded in precisely the same way. Pension scheme rules
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There are many other ways in which pension scheme rules might deal with price inflation, but we will use these two examples to highlight the complications.
Why does this cause a problem?
The Government appears originally to have intended to introduce this change simply by switching from using a RPI based figures to a CPI based figure when publishing percentages for pension increases or deferred revaluation under the legislation.
Under Example B, this might have meant, in simplified terms, that the pension scheme would start basing pension increases on CPI rather than RPI.
However, if the Government made the change in that way, the pension scheme in Example A would continue to use RPI. This is because it explicitly states that RPI should be used.
The problem here is that, at present, the pension schemes in Example A and Example B would both use RPI. However, making the change to CPI in the way proposed would mean that only the Example B pension scheme would automatically use CPI. This is despite the fact that there might be no reason why the rules in Example A and Example B were drafted differently, other than the preference of the individual who drafted them.
If the pension scheme in Example A wanted to use CPI, an amendment might need to be made to the rules. However, trying to do this could raise significant issues in relation, for example, to whether such an amendment might impact on a member’s accrued rights.
There is also concern that, in a pension scheme with a provision like Example A, members would continue to receive increases/revaluation based on RPI but, if CPI ever exceeds RPI, then members would receive benefits based on the higher of the two. This would increase pension liabilities rather than, in line with Government’s aim in introducing this change, reduce them.
So what is happening now?
Many commentators have pointed out the unfairness of this approach given it will unintentionally impact upon different pension schemes in different ways. This would also go against the Government’s stated intention of allowing all pension schemes to use CPI.
The latest suggestion is therefore that the Government will introduce new overriding legislation which will apply to all pension schemes, irrespective of how their rules on pension increases and deferred revaluation are drafted. However, any detail on this is yet to be published and there are still many unanswered questions.
What do we do while we wait for clarity?
Given the uncertainty highlighted above, it is not recommended that any action be taken in relation to the potential RPI/CPI change at this stage.
Whilst the Pensions Regulator has said that “trustees should plan to communicate with members on the impact, as soon as possible, once known, even if the impact is likely to be negligible” and that trustees could even consider an interim communication, tPR also acknowledges that ‘until any legislative changes are made, trustees should ensure that they continue to take decisions relative to the current state of the law.”
You may be sending out member communications before the CPI/RPI change is finalised but which mention the basis for pension increases or deferred revaluation. In that case, we would recommend that consideration is given to including a note stating that changes are expected in this area and further details will follow.