Some employers are concerned that although RPI is dipping into negative figures, they will not be able to reflect this by reducing the rate of pensions in payment. This effectively means that pensioners are receiving an above inflation increase to their pension, which will have to be paid for by the employer. Scope for reducing pensions is very limited.
Can schemes reduce pensions in line with RPI?
Most scheme rules (tracking the legal requirements) contain wording along the following lines: "pensions shall be increased on 1 April each year by the lesser of the percentage increase in the Retail Prices Index during the previous calendar year and 5%".
The crucial word is "increase". Mathematically it may be possible to speak of a negative increase but in legal terms it is very hard to read the word "increase" twice and take that to mean pensions can be decreased. Schemes can provide no increases where inflation is zero or negative (unless a minimum increase applies) but cannot reduce the pensions in payment.
Could a scheme offset any negative inflation against future rises in inflation?
Pensions are increased annually by reference to the annual RPI increase. An inflationary year will show an RPI increase notwithstanding there may have been prior deflationary years. So one year's deflation cannot be used to set off against another year's inflation.
Effectively the deflation may be set against future inflation indirectly if the rate of inflation begins to run in excess of the 5% or 2.5% cap applicable in respect of different periods of service (in that we expect that employers would take the previous period of deflation into account in considering whether to offer discretionary increases in excess of the minimum LPI increases). This may be small comfort to employers who would not have offered discretionary increases in any case.
Revaluation of deferred pensions
Revaluation under most schemes operates by reference to a statutory calculation which again does not contemplate that pensions will be reduced. However revaluation, unlike annual pension increases, is applied once to cover the period between leaving service and drawing a pension. The Revaluation Orders made by the government give a percentage increase covering a number of years, which reflects the overall cost of living increase throughout this period; if this includes periods of deflation these will be offset against periods of inflation.