Pension increases: moving from RPI to CPI

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

The Court of Appeal has given judgment in the Barnardo's case concerning switching from RPI to CPI for annual pension increases. The findings of the High Court have largely been upheld.

A switch from RPI to CPI for pension increases and revaluation could significantly reduce scheme liabilities and is something which employers may be considering. One key issue is whether statutory restrictions (‘section 67’) on modifying accrued benefits bite to prevent a change in index in relation to past service benefits. Although it did not form part of the formal findings, the Court of Appeal in Barnardo's commented with approval on previous High Court decisions which decided that the restrictions do not bite where an existing power within the scheme is being exercised to change the index.

Turning to the facts in Barnardo's, the relevant rule provided for annual pension increases by the percentage rise in the ‘Retail Prices Index’ capped at 5%. Retail Prices Index is defined in the rule as RPI ‘or any replacement adopted by the Trustees without prejudicing Approval’.

The main question was whether this means:

1. RPI or any index that replaces RPI and is adopted by the trustees; or
2. RPI or any index that is adopted by the Trustees as a replacement for RPI?

Two of the three Court of Appeal judges held that 1. is the correct interpretation. The trustees’ discretion to adopt a different index only arises once RPI has been replaced with another index or indices by the authority which publishes it. The third judge disagreed with this, finding for interpretation 2. i.e. the trustees do have power to select a replacement index. The Court of Appeal makes decisions by majority and so interpretation 1. prevailed.

Having found in favour of interpretation 1., the section 67 issue did not fall to be decided. However, the Court of Appeal did consider the point as an aside and concluded that a switch from RPI to CPI for all service would not be caught by section 67. Under the rules the trustees have a choice of index (subject to a replacement having been made in accordance with the finding above) and until that choice is exercised it is not possible to say that the member has a right to an increase measured in any particular way.

The starting point for employers wishing to consider moving away from RPI is to undertake a detailed analysis of the pension increase and revaluation provisions in the scheme rules, taking particular care to look at the relevant definitions. If the trustees hold the power to select a new index (or it is a joint power) then the employer will need to present a proper justification to the trustees as to why they should change index. This may include, among other things, evidence as to the improved security and sustainability of the scheme or resolving funding issues. Where the employer has a unilateral power of selection, it can exercise it in its own interests but will be constrained by its duty of good faith (including the consideration of any reasonable expectations the members may have).

Detailed advice should be taken before embarking on a switch.