Brexit is bad news for pension schemes. Since 23 June, we have seen falls in equity markets and increases in the cost of purchasing annuities. In this environment, the appearance of "negative" revaluation may actually be viewed in a positive light. We examine what "revaluation" is and explain how recent changes may benefit pension scheme solvency.
The trustees of defined benefit pension schemes apply a statutory annual percentage, known as the revaluation rate, to the preserved benefits of deferred members. The applicable revaluation rate is decided by the Minister for Social Protection (the "Minister") and is notified to the industry in a statutory instrument that is published each year.
The purpose of applying the revaluation rate is to ensure that the value of the preserved benefits in defined benefit pension schemes maintain pace with changes in the annual rate of inflation. In recent years, we have seen a very low revaluation rate being applied, 0.5% in 2013 and 0.2% in 2014, mirroring the low inflationary environment that we are experiencing.
In April 2016, the Minister announced that she was setting the pensions revaluation percentage at -0.3% for 2015. This is the first time the revaluation percentage has been a negative value. The imposition of a negative revaluation has the potential to lead to a reduction in the value of preserved benefits in defined benefit pension schemes.
Pensions legislation did not anticipate preserved benefit decreases, and confusion exists on whether or not downward adjustments can be made. References to preserved benefit "increases" are common in pension scheme documentation because many revaluation provisions were drafted at a time when downward adjustments were not anticipated.
Reacting to negative revaluation – next steps
We advise trustees and employers to undertake a review of their trust documentation in order to establish what course of action their revaluation provisions allow.
Ultimately, every pension scheme is different and the correct strategy for handing the negative revaluation rate needs careful consideration having first assessed the relevant provisions of the scheme documentation. It may be that an amendment to the scheme documentation is required to take account of the negative revaluation rate.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.