Pension Increases – the change from RPI to CPI

Introduction

In June’s Emergency Budget the Coalition Government announced it intended to use the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI) as the measure for applying increases (both in deferment and to pensions in payment) to public sector pensions from April 2011.

Steve Webb, the Pensions Minister, has now announced that this change will also apply to private sector occupational pension schemes.

Key points

From April 2011, the statutory minimum requirement will be for pensions to increase by the lower of 2.5% and CPI (not RPI).
This will apply to all accrued rights and potentially reduces a scheme’s liabilities.
But depending on the drafting of the scheme rules, the statutory change to CPI may not override the pension increase provision in the scheme rules.
Full details of how this change will be implemented are still not available and definitive advice cannot yet be given.

Pensions increases

Currently, the statutory requirement for occupational pension schemes is that pensions in payment must be increased by the lower of RPI and 2.5% (which is known as “limited price indexation” or LPI).1

From April 2011, the index used for LPI will be switched from RPI to CPI. The announcement makes it clear that:

this statutory requirement will apply to all rights a member has already accrued – not just future service rights
if a pension is already in payment, a member will remain entitled to the increases already granted but future increases on the whole pension may be based on CPI not RPI; and
schemes can provide greater increases if they wish.

The rate of revaluation for pensions in deferment will also change in a similar way (again, with revaluation already granted on an RPI basis being protected).

Rule Amendments

Depending on the drafting of the scheme rules, the statutory change to CPI may not override the pension increase provision in the scheme rules.2 For example, a DB scheme which specifies RPI for calculating LPI will need to be amended if the change to CPI is to apply.

The proposed changes will need to be considered carefully in light of the protections to subsisting rights3 as well as the scheme’s own amendment rule.

Decrease in liabilities?

The annual rate of increase of CPI in June 2010 was 3.2% whilst RPI was 5.0%.4 Understandably, therefore, the main focus has been the possibility that pension liabilities will decrease.

But, in fact, depending on how the amendments are structured, a guarantee that increases will not be less than CPI may have to be built into scheme rules even if a scheme preserves RPI – potentially increasing liabilities for those years where CPI is higher than RPI.

Investment issues

The change from RPI to CPI increases might affect a number of other areas, such as investment arrangements. At the moment many schemes use index-linked gilts and swaps to manage inflation risk. But all available hedging investments are RPI not CPI linked.5 It remains to be seen how quickly CPI linked instruments will develop. In the meantime, schemes may wish to review hedging strategy.

Detailed changes not available

As with so many pensions issues the devil is in the detail. We are still waiting for the amendments to legislation which will implement the change. Once we have further details we will write to you again.

1 The 2.5% cap applies to pensions accrued since April 2005, for pensions accrued between April 1997 and April 2005, LPI is 5% or RPI
2 There are similar considerations to the position when LPI was reduced from 5% to 2.5% – see our News dated March 2005
3Under the Pensions Act 1995, section 67
4 CPI measures the change in the cost of a fixed basket of products and services. RPI is based on the cost of a fixed basket of retail goods
5 Indeed, very few readily available instruments are even currently based on LPI rather than simple RPI