1 August 2016
In 2011 the government changed the way in which public sector schemes’ benefits were uprated from RPI to CPI. Is it time for government to permit the same for private sector plans?
Following the change to public sector schemes (civil servants, teachers, nurses etc), the knock on effect for private sector schemes has proved to be complex. Some have rules that simply followed the public sector which meant that members now have benefits linked to CPI; some refer specifically to RPI; while for many others the position is ambiguous. There have been a number of notable legal cases in which the courts have been asked to decide what a particular set of rules actually mean.
Why is there so much variation? Some rules were originally written as long as 30 to 50 years ago without ever imagining a situation such as this and in those cases it can be a matter of luck how the original draughtsman drew up the rules.
This is an important issue. In the long run RPI is expected to give materially higher increases each year than CPI. A switch to CPI thereby reduces the cost of providing scheme benefits by reducing members’ entitlements.
Ever decreasing gilt yields have meant that liability measures have continued to grow almost exponentially, leaving UK occupational DB schemes in an almost permanent deficit position. The Brexit referendum has only exacerbated this issue. In an ever increasing number of cases, schemes have little prospect of ever being able to eliminate their deficits and therefore being able to deliver the benefits promised.
There are two events occurring this autumn that may bring this issue to a head. First is the Tata Steel pension scheme’s arrangement – where in order to make a purchase of the Tata Steel’s UK businesses more appealing, the Government is consulting on a number of issues including whether its pension increases can be reduced as permitted by the scheme’s rules until 1997 when the government legislated to prevent such changes. If the outcome is that government permits this type of change, surely it must provide the same flexibility for all other private sector schemes.
The second is an appeal court case which is expected to rule on whether private sector schemes in general can switch from RPI to CPI in relation to accrued service. If it is ruled that this is not permissible, it certainly would be unfortunate for schemes that have already chosen to do this, as they would need to unwind the changes made. But more importantly, most private sector schemes will then be locked into providing RPI increases – or, in some cases, higher increases - whereas public sector schemes provide CPI increases. Can this be right?
When deciding whether to substitute CPI increases for RPI, employers and trustees have two questions to answer:
- Could they make the switch?; and
- Should they make the switch?
On the first point, the Government must fix this lottery. There should be a level playing field for all. Overriding legislation is necessary to deliver this. This may not be popular amongst members and will have political consequences, but the present position is surely unsustainable.
On the question of should the change be made, this is rightly a matter for trustees and employers to determine according to covenant, funding position and the complex individual circumstances of their pension scheme. For instance, poorly funded schemes with weak employers may find that, by reducing entitlements to future increases, members can be more certain of getting their benefits rather falling back on the PPF. For some schemes it may be the only way to balance the interests of different generations of pensioners.
In any event, all parties will need clear advice to help them reach a conclusion. LCP has plenty of experience helping trustees and employers wrestle with such decisions. In one case, we have helped put in place an agreement in which CPI increases are payable until such time that RPI increases become affordable again.
If common sense prevailed and government legislated for a level playing field everyone would have a clearer idea of the viability of their scheme. That must be better for all concerned.