More developments on switching from RPI to CPI
1st March 2018
Since the Government switched from using RPI to CPI as the basis for statutory pension increases and revaluation in 2010, there has been a focus on whether wording in scheme rules allows schemes to make this change or whether they need to continue calculating pension increases and/or revaluation by reference to RPI.
Where rules simply refer to making the increase required by law then the change flows through automatically. However, many sets of rules are more precise and define the index to be used and set out when it can be changed. Because the cost of providing RPI increases (on recent data) can be as much as 10% higher than the cost of CPI increases, there have been a number of court cases seeking clarity on whether particular scheme rules allow a shift to CPI.
Case in point
So far cases have considered wording allowing the use of another “suitable cost of living index” (QuinetiQ – 2012), a “similar index satisfactory for the purposes of the Inland Revenue” (Arcadia – 2014), RPI or “any replacement adopted by the Trustees without prejudicing Revenue Approval” (Barnardo’s – 2015 and 2016), or an alternative index where the compilation of RPI is “materially changed” (Thales – 2017). We now have one more case to add to the list: British Telecommunications Plc v BT Pension Trustees Ltd.
In this case, the rule at issue provided that: “The cost of living will be measured by the Government’s published General (All Items) Index of Retail Prices or if this ceases to be published or becomes inappropriate, such other measure as the Principal Company, in consultation with the Trustees, decides”.
The court was asked to determine what this provision actually meant, when RPI could be said to have “become inappropriate” and who could make that decision.
The judge started by referring to the general rules of interpreting pension scheme documentation which were set out by the Court of Appeal in the Barnardo’s case:
- Pension scheme rules are, in principle, to be interpreted in the same way as any other document. The court must focus on the meaning of the relevant words in their documentary, factual and commercial context.
- That meaning has to be assessed in the light of (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions of the document, (iii) the overall purpose of the clause and the document, (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party’s intentions.
- Reliance on background and commercial common sense must not be allowed to undervalue the importance of the words of the document. In addition commercial common sense cannot be invoked retrospectively.
Rulings by the judge
In light of these principles, the judge held in this case that:
- The fact that the requirement for RPI to become “inappropriate” was capable of a broad range of interpretations did not mean that the provision conferred a discretion on the parties to determine whether it was appropriate. This was an objective question of fact which, in the case of doubt, was to be determined by the court.
- “Inappropriate” is a word with an ordinary English meaning. It is not enough that it would be better to use another index, or that another index has become more appropriate, or that RPI is merely undesirable.
- The reference to a switch being made if RPI “becomes” inappropriate did not preclude the court taking into account matters which might have occurred before the rule took effect.
- The concept of appropriateness does not exist in a vacuum, but relates to some other thing or purpose. In this context, it “relates to the purpose for which the Rule exists, namely calculating an increase in pension payments so as to reflect increases in the cost of living of pensioners receiving benefits under the Scheme”.
- It was not necessary for the composition of RPI to change for it to become inappropriate, changing perceptions and views could make it inappropriate.
- A great deal of expert evidence was provided by all sides on the appropriateness of RPI. The judge concluded that any “index can do no more than provide an estimate of the increase in cost of living as experienced by any given household, or even type of household. Thus, it is impossible to say that RPI is wrong and CPI is right, or even that RPI is more wrong (or right) than CPI, as an estimate of the likely increase in cost of living for pensioners under the Scheme.”
The result was that, in the opinion of the judge, RPI had not “become inappropriate” for the purposes of up-rating pensions.
The judge also said that had BT alone had the power under the rule to determine whether RPI was inappropriate (which he had found it did not), it would have been a fiduciary power (so BT would need to exercise it for the benefit of the scheme beneficiaries rather than in its own interests). In addition, in terms of whether it would be reasonable for BT to have determined that RPI was inappropriate, the judge said “the fact that a respectable body of opinion believes that RPI has become inappropriate would make a challenge to a decision by BT to that effect very difficult to sustain”.
Finally, where scheme rules do have a discretion allowing employers and/or trustees to switch from RPI to CPI, the case provides some useful expert analysis on the composition and status of each index and industry views in relation to each.
So what broader conclusion can be drawn from this case?
The answer is the importance of looking at the precise wording of the scheme rules. Parties need to consider whether their rules confer a genuine discretion to change the index that is used and, if not, what the precise factual test to be considered is.
As has been previously observed, it is all a bit of a drafting lottery and many schemes are compelled to retain the use of RPI based on wording that was drafted at a time when no one could foresee ever moving away from RPI.
It is an issue that was raised in the Government’s Green Paper on the security and sustainability of DB pensions in February 2017. We are told that we will see further proposals for reform following on from this later this year but whether or not there will be any attempt to deal with this issue remains to be seen.
In the meantime – look to your rules!
For more information please contact Emma King.