DWP consults on pension scheme inflation changes

Updated December 2010

The Department for Work and Pensions (DWP) has recently published a consultation paper on the impact of using the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI) as the measure of price inflation for private sector pension schemes. The impact of this change could be that some members will stand to lose around 20% of the value of their benefits over their lifetimes.

This briefing looks at the key messages from the consultation paper and assesses its possible impact on your scheme.

What are the key proposals in the consultation paper?

The consultation paper requests responses from the pensions industry as to how future statutory revaluation and pension increases should be applied. The DWP propose that:
 

• statutory increases to pensions in payment, and the revaluation of deferred pensions, should be linked to CPI rather than RPI (as will soon be the case for public sector pension schemes);
• private sector schemes will not be forced to change from RPI to CPI where the scheme rules refer specifically to RPI; and
• legislation will not be passed to enable scheme trustees to change the pension increase/revaluation provisions in their scheme rules if they do not already have the power.

Interested parties have until 2 March 2011 to comment on the proposals in the consultation paper.

What impact will this have on my scheme's rules?

Since its introduction in 1996, CPI's annual rate of inflation has been around 0.8% lower than RPI. The main reason for this is that, unlike RPI, CPI does not take account of mortgage interest payments and other associated housing costs. Consequently, the value of members' benefits in the long term is likely to be much higher linked to RPI rather than CPI.

If these proposals are implemented, both pension scheme trustees and employers will need to look closely at the provisions in their scheme rules.

Whilst every scheme is different, and many schemes have other complex provisions, broadly most schemes will fall into one of the following three scenarios:

• where your scheme rules specifically link revaluation and pension increases to RPI, the proposed changes will have no effect on your scheme. Future indexation and revaluation will continue to be calculated by reference to RPI;
• where your scheme rules require only statutory revaluation and pension increases, or are silent on both, future increases and revaluation will be calculated by reference to CPI instead of RPI; or
• where your scheme rules have mixed provisions (e.g. statutory revaluation but pension increases specifically linked to RPI) both indices will still be relevant. In this case, future revaluation would be calculated by reference to CPI, but pension increases would remain linked to RPI.

What if RPI turns out to be lower than CPI in any given year?

There had been suggestions that if at any point in the future RPI was lower than CPI (as it was in September 2009) then scheme increases would need to be given as the higher of RPI or CPI (creating an underpin). However, the DWP have made it clear that any scheme choosing to stick with RPI increases would not have to pay CPI increases in any year in which RPI was lower than CPI.

My scheme rules refer specifically to RPI – is it possible to amend them to change to CPI?

It seems clear that where a scheme's rules specifically refer to RPI then revaluation and future increases will continue to be applied on that basis. The DWP was reluctant to force a change to private sector schemes where RPI increases may well have been secured through careful planning or tough negotiations. However in such circumstances employers may wish to change the relevant provisions in their scheme rules to switch to CPI increases.

First, in order to make such a change, the power to make the amendment must exist in the scheme rules. The consent of scheme trustees is likely to be required before the amendment may be made. Secondly, before such a change may be made the DWP has proposed that a switch from RPI to CPI for future service shall be made a "listed change" under the Occupational and Personal Pension Schemes (Consultation by Employers) Regulations 2006. This will require the employer to consult with affected members for at least sixty days before such a change is implemented. Employers have a duty to consider the members' responses.

If a change is proposed which would have retrospective effect (altering the value of members' benefits already accrued) then this would require the informed consent of the affected members to comply with Section 67 of the Pensions Act 1995. Detailed advice should be taken before considering such a course of action.

How will this affect existing buy-ins/buy-outs?

Many schemes have secured buy-ins or buy-outs with insurance companies with increases already linked to RPI. The change to CPI indexation and revaluation will not directly affect such existing policies. However, the situation may well arise that some schemes are in fact better off as a result of the change. As an example, a scheme's rules might provide for statutory increases, but the terms of a buy-in policy covering pensioner members might require the insurer to apply RPI increases. In such circumstances the scheme trustees could elect only to pass on CPI increases to the pensioners, with the difference held in the scheme. Many such schemes may therefore decide to seek to renegotiate the terms of an existing policy, either to arrange more preferential terms or to increase the number of members covered by the policy.

Conclusion

Although at this stage the proposed changes to pensions inflation are not set in stone, the consultation paper has at last given clarity to the DWP's original statement made in July 2010. Pension scheme employers and trustees should take time to consider how the proposed changes might affect their scheme arrangements, and if necessary steps should be take to ensure that the scheme rules reflect the collective intentions of all parties. 

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