The index used for the purposes of determining revaluation of deferred benefits and increases to pensions in payment is a topic which many trustee boards and employers alike are watching keenly.
The index used can make a vast difference on the cost of providing benefits. We have seen a number of Trustee boards coming under pressure from the sponsoring employer(s) to switch from RPI to a more appropriate index, with the replacement index more often than not being CPI.
The suitability of RPI for indexation of pension benefits has come under increasing criticism over recent years and months, further bolstering employers’ preferences to move away from RPI.
The question of whether the index can and should be changed comes down to a number of factors, primarily:
- Can the index be changed? – i.e. do the governing documents provide the trustees/and or the employer with a power to change the index, if so what (if any) conditions are attached to the exercise of power?; and
- Should the index be changed? – this is where the relevant party/parties need to consider relevant factors such as the suitability of the index.
There has been an increase in the number of cases going to the courts on this subject. In December 2016 Clive Weber reported on the Barnardo’s judgment and on 31st March the latest judgment on this topic was handed down by the High Court, in respect of Thales UK Ltd v Thales Pension Trustees Ltd and others.
The facts related to the Thales scheme
Under the Thales UK Pension Scheme (the Scheme) the questions concerned the index used for:
- Revaluing the salary used to calculate career average revalued earnings (CARE) style benefits for service from January 2008.
In respect of these benefits the court considered whether the compilation of the RPI had “materially changed” over the years, in which case the Company and the Trustee would have the power to change to a new index. The relevant rule specified:
“If the Government retail prices index for all items is not published or its compilation is materially changed, the Principal Employer, with the agreement of the Trustees, will determine the nearest alternative index to be applied.“
- Increasing pensions in payment in respect of final salary benefits which had been transferred into the Scheme from the Thales Optronics Pension Scheme (TOPS):
In respect of these benefits the court considered whether RPI has been “otherwise altered”. The relevant rule provided:
“If the Retail Prices Index is revised to a new base or if that Index is otherwise altered…“
Decision
It was noted that the basket of goods used to determine RPI has changed several times over the years. The Court then considered whether a change to the basket of goods meant there had been a material change to the index itself:
“The expert evidence shows that routine changes in the compilation of the RPI are an inherent aspect of its maintenance as an index which is fit for purpose. Having rejected the effect of the changes as a relevant factor in assessing materiality, my judgment is that routine changes in compilation adopted to improve the RPI and keep it fit for purpose are not material changes in its compilation; a routine change in compilation will never be a material change.”
The conclusion was that the changes to the basket of goods did not constitute a material change to the index itself even where it had a material change on the benefits payable.
The sponsoring employer had also argued that the freeze in 2013 in changing the index in future apart from particular circumstances amounted to a “material change”. The Court considered and dismissed this argument:
“On this issue, I prefer Mr Green’s submissions. It is not really possible to elaborate on them. In my judgment, the “freeze” is so opaque and its consequences so unpredictable that it cannot sensibly be described as a change in compilation at all. And the fact that it appears to have had no effect, let alone a material effect, on the level of the index suggests that there has been no material change in compilation even on the Company’s approach to materiality.”
Aside from the contents of the basket of goods which make up RPI the Court also considered the fact that the housing cost component of RPI changed in 2008. Until 30 June 2008 the housing component of RPI was based on the House Prices Index (HPI) but it subsequently changed to a tailored version of a new housing index which the Office for National Statistics had started to publish.
The Court concluded that the change from HPI to a tailored version of UK HPI was not a routine change, and accordingly, represented a material change to the compilation of RPI. As a result of the Scheme Rules the sponsoring employer was then required to consider the nearest alternative index. Accordingly, the Court then considered “what is the next nearest alternative index”?
Warren J stated that “the nearest alternative index must be the one which most closely reflects the existing elements of the RPI”. His reasoning was that RPI, following the introduction of UK HPI, was not to be discounted from the analysis of the nearest alternative index. Indeed, he concluded that RPI, with UK HPI, was in fact the nearest alternative index and that the sponsoring employer could not reasonably adopt any other index.
In relation to the TOPS benefits the Court found the test to be broader than that which applied to the CARE benefits. Whilst the Court agreed that RPI had been “otherwise altered” the replacement index should be one which mirrored, as closely as possible, the original index before it was otherwise altered”. The result being that RPI, with the tailored version of UK HPI, was the most appropriate index to use.
Comment
We expect a number of employers will be frustrated by the conclusion of this case. However, it highlights the requirement to ensure the exact provisions in the scheme’s governing documents are fully complied with. Simply because a swathe of the industry feels CPI is more appropriate doesn’t mean restrictions in scheme rules will be overlooked in order to facilitate a switch from RPI to CPI.