What benefit indexation should your scheme use?

In broad terms, legislation has required revaluation of all deferred benefits for members who left pensionable service on or after January 1 1991, and increases to pensions in payment accrued on or after April 6 1997. Historically the inflation index to be used for both revaluation and pension increases was the retail price index.

However, in July 2010 then-pensions minister Steve Webb announced that the index to be used was to change to the consumer price index. Since then, trustees have grappled with whether they could and/or should move from RPI to CPI.

Differences between RPI and CPI

There are two main differences between RPI and CPI. The first relates to the basket of goods. The second is the methodology.  

There are a number of differences between the basket of goods used to determine RPI and CPI, the main point of difference being that RPI includes housing costs whereas CPI does not.

In terms of methodology, RPI is determined using the arithmetic mean (the sum of a series of numbers divided by the count of that series of numbers) whereas CPI is found using the more complicated geometric mean.

CPI is said to better reflect changes in consumer spending patterns relative to changes in price.

Historically CPI has produced a lower rate of inflation than RPI. Although RPI is no longer an officially recognised national statistic, it could not be discontinued because it is used, for example, to set gilt yields.

The government unilaterally moved to CPI as the inflation measure for public sector pension schemes but has refused to give private sector pension scheme trustees the power to make the same change

Wording of scheme rules decides

CPI may more accurately reflect price increases, but whether or not private sector pension schemes are able to adopt CPI as their inflation measure depends on their scheme rules.

The government did not opt, as it did for public sector pension schemes, to make the change to CPI overriding.

The courts have considered in a number of cases both whether or not the trustees had the power to switch from RPI to CPI and whether or not that switch would offend the section 67 requirements which prevent amendments that would adversely affect a member's accrued rights and/or entitlements unless the member has consented.

The most recent of these cases is Buckinghamshire v Barnardos (Court of Appeal, 2016).

The key learning points from the decided cases are: firstly, a switch to CPI is not contrary to section 67; and secondly, whether or not CPI can be used in place of RPI depends on the drafting of the scheme's rules.

In Buckinghamshire v Barnados the rules defined RPI as "the General Index of Retail Prices or any replacement adopted by the Trustees".  

The court held that "replacement" meant replacement by government, and that the trustees did not have the power to switch to CPI as long as RPI remained an officially published index. The fact that RPI is no longer recognised as a national index did not constitute a replacement of RPI.

In contrast, in the Arcadia case in 2014, the High Court ruled that RPI defined as "the Government's Index of Retail Prices or any similar index satisfactory for the purposes of [HMRC]" allowed the trustees to move to CPI.

What may the future hold?

It is somewhat unsatisfactory that the government unilaterally moved to CPI as the inflation measure for public sector pension schemes but has refused to give private sector pension scheme trustees the power to make the same change. Trustees are, therefore, at the mercy of the particular drafting in their rules.

That said, much parliamentary time has been spent recently considering the law and regulation of defined benefit pension schemes, and the December 2016 Work and Pensions Committee report recommends that the forthcoming Green Paper addresses this issue.

We shall just have to wait and see whether or not the government does, after all, have the appetite to consider the RPI/CPI conundrum.

Ruth Bamforth is a senior associate at law firm Walker Morris