Employers seeking to switch their defined benefit pension schemes from the retail price index to the consumer price index have been dealt another blow, as the High Court yet again refused to establish a precedent.
Inflation measures have been the focus of several technical disputes in recent years, owing to the large difference that a discrepancy of around a percentage point a year can make to scheme deficits and member benefits.
Engineering group Arup had argued that RPI had been “functionally replaced” because the Office for National Statistics had adopted CPI as its main measure of inflation. RPI has attracted criticism as an inaccurate measure, but remains hardwired into many scheme rules.
Lawyers for Arup argued that its rules allowed more flexibility, and that the trustee of the Arup UK Pension Scheme would be justified in abandoning RPI.
This case again shows what a lottery it is going to court
Jeremy Goodwin, Eversheds Sutherland
Much of the case hinged on what exactly replacement entailed, and whether an index being “functionally” replaced by the ONS was sufficient to justify its actual replacement, within the context of a scheme’s rules, by another index.
The judge found that the functional replacement of RPI did not entail its actual replacement, as this would require the index cease to be published.
The case then rested on an interpretation of the Arup scheme’s own rules. While the judge found in principle that a switch could be made due to a change in RPI composition in 2017, the specifics of its rules were found to exclude the possibility of a switch to CPI.
Court decisions ‘a lottery’
Employers hoping to use the court system to establish a legal precedent for a switch to CPI will be disappointed, as the High Court decision provides yet more evidence that courts will rule based on the wording of individual scheme’s rules rather than setting a more general precedent, said Jeremy Goodwin, partner at law firm Eversheds Sutherland.
He said such “randomness” makes things difficult, because, while most schemes’ rules would have been drafted with RPI in mind, “each set of rules would have been drafted with a different set of lawyers, with a different precedent, or a different consultant, and with different wording”.
“That kind of randomness in relation to the words that were chosen is now, years down the line, being looked at by courts, and big decisions are being taken based on exactly what wording was chosen, to impose a court’s view as to what they might mean as opposed to what was intended,” Mr Goodwin noted.
Besides making things difficult for lawyers who might look to advise clients on the likely outcome of their cases, this approach to deciding which indices schemes may or may not use can leave employers with little chance to make changes, he added.
As a result, they may end up “stuck with RPI simply because of what wording was chosen 30, 40 or 50 years ago”.
“The key message from my perspective is that this case again shows what a lottery it is going to court. It feels a very strange and unwelcome place to have ended up,” Mr Goodwin said.
Huge amounts at stake
Critics of a move to CPI point out that, while it might be good for employers, it amounts to a loss for affected members. Because the indices account for slightly different things (RPI accounts for housing-related costs, CPI does not) and are measured in slightly different ways (RPI uses an arithmetical mean, while CPI uses a geometric mean), they produce different results.
Between 2000 and 2012, RPI grew an average of 1.2 percentage points a year more than CPI, and the most recent inflation figures published by the ONS bore this out, with CPI falling to 0.9 per cent in April from 1.5 per cent in March, while RPI fell to 1.5 per cent from 2.6 per cent over the same period.
The significant financial implications of switching to CPI explain why so many of these cases find their way to court, said Hadassah Shulman, senior associate at Taylor Wessing.
“This case demonstrates exactly why this remains a popular question – there are huge sums at stake. In this case, it was said the deficit might reduce by between £75m-£85m,” she said.
While the High Court ruling dismissed the suggestion RPI had been replaced, it did find that the 2017 change to RPI’s composition gave “trustees the power to make changes to the pension increase calculation, provided this was done within a reasonable time of the change and those adjustments were fair and reasonable for the purpose of counteracting or mitigating the change in composition”, Ms Shulman explained.
In the Arup case, the judge found that the proposed change to CPI failed the “fair and reasonable” test.
Ms Shulman added that, should the Treasury enact proposed changes to RPI methodology following its consultation, we should expect to see more such cases brought before the courts.
“The proposed RPI change could mean that trustees of schemes with the relevant wording may once again have the power to make changes to the pension increase calculation,” she said.
Settled out of court?
Other avenues exist, however, with a number of companies successfully switching their schemes to CPI without ending up in court, according to Alex Waite, partner at LCP.
“To my mind, if you hear that the case has gone to court, that means the company has already lost,” he said.
“The lion’s share of court cases go against the company because you’re then arguing about whether they can force the trustees to do something, and the answer, usually, is ‘no’.
“The question shouldn’t be ‘can I force you?’, it should be ‘is this the right thing to do?’”
Mr Waite added that the key to this approach is to “bring trustees with you”, by explaining the thought process and making the case that CPI satisfies the promise made to scheme members to protect them against inflation.
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“In some cases, [switching to CPI] can halve deficits, and in extreme cases it can remove deficits,” he said.
“If you explain it in those terms, bring trustees along with you as part of that thought process, then we’ve seen a number of cases where the change has been made because the trustees see that it makes sense, and none of those cases have gone to court.”
For trustees of schemes where the move to CPI is a genuine option, but who are reluctant to be seen to adopt an index that results in fewer benefits for members, Mr Waite said that companies should ask “why they should take the half of people who are pensioners and pay them more [than the CPI level] while there’s a risk the other half won’t even get their pension?”
