The case for discretionary increases is becoming compelling

According to the PPF’s Purple Book 2023, about 20% of schemes don’t provide increases on pre-1997 excess.

This is thought to affect over 700,000 pensioners, and analysis undertaken for the Hewlett Packard Pension Association indicates that more than half a million may not have received increases for many years.

The impact has been the destruction of the buying power of their pensions – for some, by more than half.

Scheme rules are key

Whether these pensioners are at the mercy of their former employers will depend on the scheme rules.

These could be silent on increases, save for the augmentation rule, or include a power to award pension increases. Such a power could be unilateral – trustee or (more usually) employer – or joint, and it is important to examine the wording in each case.

For example, a joint power that says pensions “shall be increased… by such amount as the principal employer and the trustees shall decide” indicates that the discretion relates to the amount, and you could argue that a positive increase is expected.

Alternatively, the power may require trustees to review pensions and to seek the actuary’s advice on whether an increase is appropriate – but any increase can only be awarded with the employer’s agreement.

In such cases, you would expect to see evidence of annual reviews, the actuary being consulted and the trustees making proposals to and discussing them with the employer.

Unilateral trustee powers are less common than pure employer ones, but typically there will be a requirement to review the pensions and discretion over the amount of increase.

Phrases such as “increase (if any)” may raise the possibility of no increase, but the rule may also direct the decision maker to take actuarial advice and consider the scheme’s funding.

The key takeaway from such rules is that the sponsor designed the scheme to provide benefits with pension increases, but without the guarantee of a set annual increase. These increase rules were included for a reason and form part of the schemes’ design and purpose.

The award of increases should not be approached with the mindset that they are not required by legislation so there’s no need to pay them. Legislation has never provided for these pensioners, but the scheme rules do.

How should trustees approach this issue?

Trustees have fiduciary duties, in particular to act in the best interests of members. This means all members and there are likely to be different cohorts to consider.

What is clear is that trustees should do what the rules require them to do and they may be required to review these pensions at the very least.

Where they have discretion to award an increase, trustees must actively consider whether or not to exercise it. It’s important to manage conflicts and come to a decision that is independent from the employer.

In exercising their power, trustees should consider the purpose of the scheme and the power they’ve been given, and make enquiries to ensure they have the relevant information.

Other relevant factors are likely to include the inflation experience, the various member categories, any relevant expectations of or representations from the pensioners concerned, the employer covenant, the employer’s views and the scheme’s journey plan.

The courts won’t interfere with the trustees’ decision unless it is one which no reasonable body of trustees could have reached. This is an irrationality test – a high bar – but to have that protection, trustees need to be able to demonstrate that they have followed a proper process.

What about employers?

Employers’ duties towards scheme members are not fiduciary, but stem from employment law. They must exercise scheme powers in good faith for the purpose for which they have been given.

Unlike trustees, employers are not under an obligation to members to actively consider whether or not to exercise their powers and may take account of their own commercial interests.

Where an employer does consider exercising its power, it also must take all relevant circumstances into account and its decision must be rational. Relevant factors include the employment context and the purpose of the power, as well as the factors mentioned previously, and the employer has to weigh them all up when making its decision.

Employers are in a strong position, but how long will it be rational for employers to refuse increases to pensioners whose benefits have been seriously eroded by ongoing inflation, particularly if the scheme is fully funded or in surplus?

Employers might say that they have paid substantial deficit contributions in recent years and don’t wish to increase their liabilities, particularly where a current surplus falls short of buyout funding.

But is it also relevant to consider what benefits those contributions have paid for? Would that include ongoing accrual for active members (an employer decision) or increases enjoyed by later joiners? Have older pensioners been paying the price for that and should this continue? And should the pursuit of higher profit deprive the increase rule of its purpose?

What about the courts?

It is fair to say that case law has not been kind to pensioners. The courts and Pensions Ombudsman have given employers a good degree of protection if they have followed their rules and undertaken a proper process, but employers cannot take for granted that this trend will continue.

The case for increases is becoming more compelling. If the increase rule is to have any purpose and meaning, it is becoming a case of ‘if not now, when?’.

Claire Rankin is a partner at law firm Osborne Clarke