Case Focuses On Whether Pensions Can Be Linked To CPI

The judgment in the recent case of Danks v Qinetiq Holdings Ltd could prove welcome news for cash strapped UK employers trying to contain the costs of operating defined benefit schemes, Anne Taylor, Irwin Mitchell’s national head of pensions explains.

The case arose out of the Government’s decision to introduce legislation which would link pension increases to CPI, instead of RPI.  CPI has historically been at a lower rate than RPI leading to potential cost savings.

Under the legislation, whether private sector defined benefit schemes can benefit from a move to CPI depends on their scheme rules.  If the rules merely referred to pensions increasing in accordance with legislation, then future pension increases were automatically linked to CPI.  If the rules explicitly stated RPI (known as RPI being “hard-wired” into the rules), then a rule change would be needed which would involve obtaining trustee consent.  Some schemes have rules which allow an alternative to RPI to be substituted.  

Perceived problems with changing the rules or switching to another index included difficulties in satisfying section 67 Pensions Act 1995.  This precludes modifications which prejudicially affect a member’s “subsisting rights”.  There is uncertainty whether section 67 means that the switch could only be made for future pension accrual and not future increases to the member’s pension, on the basis that the increases to a member’s pension were “subsisting rights”.

In the Qinetiq Holdings case the scheme rules provided that pensions in payment and deferred pensions were to be increased annually by the increase in the “Index”, defined as

“ . . .The Index of Retail Prices published by the Office of National Statistics or any other suitable cost-of-living index selected by the Trustees . . .”

The Trustees arguably had a discretion as to which index they chose to use.   The issue was, could they move to CPI without breaching section 67?

The Judge in the case agreed that they could.  He argued that the power to increase by a selected index was not subject to section 67, as it was not a subsisting right.  Provided the Trustees selected the new Index prior to the next annual increase date they could move to CPI for the whole of the pension, not just pensionable service after the date of change.  This meant that the funding of the whole pension was potentially favourably affected as the actuarial assumptions could be revised to reflect this.  This would apply not only to pensions in payment, but also to increases to deferred pensions not yet in payment.  The Judge was also of the view that the rules allowed different indices to be selected (subject to the Trustees giving proper consideration).

Pension scheme trustees face difficult choices in funding their schemes in tough economic times for employers.  This decision could give Trustees and employers more freedom to negotiate the benefits and funding bases for defined benefit pension schemes.  The first step is to review the scheme provisions to gauge whether there is any flexibility.