Goodbye RPI?

The Government has announced that from 2011 (by reference to 30 September 2010) it plans to use the consumer prices index (CPI) rather than the retail prices index (RPI) for statutory revaluation of deferred pensions and statutory pension increases on pensions in payment. Usually, CPI produces lower increases than RPI and so in theory would make pension scheme increases cheaper to provide for deferreds and pensioners. But there are legal reasons why CPI may not become as widely used as suggested. Unless primary legislation is amended so as to override existing pension scheme rules, what applies to each member will depend (among other issues) on whether the scheme rules expressly refer to RPI or whether they simply cross refer to the relevant piece of legislation. The potential for confusion is significant. Without a bold and clean set of changes, many schemes may find themselves saying "see you later", rather than "goodbye" to RPI.

Could the change mean differential treatment?

The short answer to this question is 'it depends on how the change is effected'. This is because the interaction between scheme rules and the legislation covering revaluation and indexation will vary from scheme to scheme. Even within the same scheme, alterations to the rules over the course of its history may well mean that different groups of deferred members and pensioners are treated differently, depending on the how the rules were drafted when they left service. The change to CPI could make things messier, unless the Government legislates to override scheme rules and apply CPI to everyone.

What are the likely scenarios for deferred members and pensioners?

Deferred members

Taking deferred members first, most scheme rules simply cross refer to the Pension Schemes Act 1993. Looking at the statutory provisions on revaluation, we think that the necessary change to introduce CPI would be straightforward to implement. So, the likely scenario for most schemes is that CPI revaluation would apply automatically. However, those schemes with rules that more fully describe statutory revaluation by referring to RPI may well find themselves having to apply RPI with a CPI underpin (an underpin would operate because the revaluation laws are overriding and therefore, in effect, set a minimum rate of increase).

Pensioners

For pensioners, the position appears more problematic. In our experience, only a minority of schemes rely on statutory cross references in their pension increase rules. It is usually the case that the scheme's indexation rule will expressly provide for RPI increases. Many schemes provide for RPI because they had pension increase rules in place before statutory pension increases were introduced in 1997.

The Pensions Act 1995 (section 51) says that the requirement to index in line with RPI (up to 5%) doesn't apply if the scheme rules already require RPI increases with a 5% cap. Changing section 51 so that references to RPI are changed to CPI will be a tough test to pass, since amending primary legislation is far harder to achieve than making an amendment to regulations. Will it mean a CPI floor for schemes containing an express reference to RPI increases?

Another major hurdle would be section 67 of the Pensions Act 1995, which restricts adverse amendments to past service benefits. Without an express relaxation of section 67, schemes expressly providing for RPI increases would be unable to provide for CPI increases for past service accrual (at least at the moment, given that CPI would produce a lower increase than RPI). The latest Ministerial Statement on the CPI change (issued on 12 July) suggests, by way of examples, that CPI will only apply going forwards, so anyone straddling the RPI/CPI regimes will have the relevant measure applied before/after 2011. So, more complexity for those running schemes.

The Government has confirmed that it also intends to apply CPI indexation to guaranteed minimum pensions, (but only from 1988 since the requirement to index GMPs, currently at RPI up to 3%, has only ever applied for accrual post-1988).

None of this affects non-statutory pension increases, which relate to pensionable service before 6 April 1997.

What to do now

Unless there is a change to primary legislation which has the effect of overriding existing pension scheme rules (which we do not think will happen in time for this year), the impact of a move to CPI will depend on the interaction between a scheme's rules and whatever steps the Government takes to bring in this change. This could involve the review of historic as well as current rules to cover each generation of members. As a result, schemes could have different groups of members treated differently depending on the drafting of the rules which apply to their benefits.

Trustees may also like to discuss with their actuary how this change in fortunes will affect funding and how much of a difference it is likely to make, although the rules must be considered first.

Aside from concerns about benefit provision, this change could have important ramifications for those who use liability driven investment strategies.

Looking ahead to the longer term, there is no certainty that when CPI becomes higher than RPI that the Government will not flip back to RPI, leaving schemes with the problem of what to do with all the references to CPI which have been written into their rules.

Goodbye RPI? Or see you later?