Increases are an important component of a member's pension, but can be costly to fund. In the latest in a line of cases, the Supreme Court in Barnardo's v Buckinghamshire has considered whether the Trustees of the Barnardo Staff Pension Scheme (the Scheme) had the power to switch the measure of inflation used for increasing pensions from RPI to CPI. Finding in favour of the members, the Court ruled that the scheme rules did not permit such a switch; only a replacement for RPI, as permitted by the scheme rules, could be used.
In order to protect against the effects of inflation, defined benefit occupational pension schemes are required by legislation to revalue deferred members' benefits and increase pensions in payment. These statutory minimum increases are to be in line with inflation as determined by the Secretary of State, subject to certain caps. Until 2010, the inflation measure used was RPI - the UK’s longest-running measure of price inflation - and many scheme rules expressly referred to RPI.
However, from 1 January 2011, the Government started using CPI instead of RPI as its measure of inflation.
From Barnardo's (the Employer) perspective a change from RPI to CPI was attractive because CPI will typically be about 0.5-1% lower than RPI, which can translate into a significant funding difference. However, the issue was whether the scheme rules allowed the switch.
The Employer claimed that the Trustees did have the power to make the substitution, but the Trustees disagreed (or at least were uncertain). Accordingly the trustees sought guidance from the court on whether they could make the change from RPI to CPI. As is common in such cases, the Trustees took a neutral position to allow the competing arguments to be run by Barnardo's and a representative member.
The scheme rules of the Barnardo's pension scheme defined "Retail Prices Index" as "the General Index of Retail Prices published by the Department of Employment or any replacement adopted by the Trustees without prejudicing Approval" (our emphasis).
The issue at stake was whether RPI in the Scheme rules meant:
- The two-stage test: RPI or any index that replaces RPI and is adopted by the trustees; or
- The single-stage test: RPI or any index that is adopted by the trustees as a replacement for RPI
The first meaning involves a two-stage process by which the RPI is replaced by the Office of National Statistics, the official body responsible for compiling the inflation indices, and the Trustees then adopt the replacement index. The second meaning involves a single step and would allow the Trustees to choose another index as a replacement of the RPI, whether or not the RPI continued to be published.
Barnardo's argued that the definition empowers the Trustees to choose to adopt another index, CPI, as long as they considered it a suitable measure of price inflation. Switching to CPI would enable a reduction in the scheme's deficit.
In September 2015, the High Court ruled that the Barnardo's scheme rules did not allow a switch from RPI to CPI. This decision was confirmed by the Court of Appeal in November 2016 and that only a replacement for RPI could be substituted for indexation purposes.
The Supreme Court rejected the Employer's appeal and upheld the decision of the Court of Appeal. The two stage test was the correct interpretation.
The Supreme Court came to this decision for a number of reasons:
- The choice of the word "replacement" does not naturally suggest the selection of a different index to the existing one where the existing one was still available and being published.
- The word order and grammatical construction of the definition suggested a sequence of events rather than the single event of a new index being adopted by the trustees.
- While RPI as a measure of inflation has fallen from favour since 1991 when the scheme rules were drafted, it was not appropriate to use hindsight to assess whether a provision made good commercial sense.
- It was also not legitimate to argue that common sense required the trustees to be vested with a power to change the index if RPI ceased properly to reflect the cost of living.The draftsman of the Barnardo's scheme rules had put his faith in the suitability of RPI and appears not to have foreseen the circumstances in which RPI ceased to be seen as an appropriate index for the cost of living.
- The court should also consider the matter without any preconceptions as to whether a particular interpretation favoured the employer or the members.
Clyde & Co comment
There have been a number of court cases relating to RPI/CPI over the last few years and this one, like many of the others, depends largely on the specific wording in the scheme rules. In that respect, it will not have much impact on other schemes which have different scheme rules. Whether a scheme can switch to CPI depends therefore on the "lottery" of what precisely the scheme rules say and in particular whether they have RPI "hard-coded" into them. The Pensions White Paper published in March 2018 ruled out giving schemes a general power to switch to CPI.
The debate as to whether RPI should be replaced rumbles on in Government circles. RPI lost its status as an official "National Statistic" in 2013 and in 2015, the Johnson Review recommended that government and regulators should work towards ending the use of RPI as soon as practicable. However, it is still being published by the Office of National Statistics and the 2018 Budget acknowledged that "given the extensive use of RPI across the public and private sectors, moves away from RPI are complex and potentially costly" (page 12).