UK: Which Inflationary Index? The Arcadia Case Sheds Some Light…

Last Updated: 3 November 2014
Article by Justin McGilloway

In the recent High Court case of Arcadia Group Ltd v Arcadia Pension Trust Ltd , the sponsoring employer of two of the Arcadia Group's pension schemes asked the court to determine whether the Consumer Prices Index (CPI) could be used in place of the Retail Prices Index (RPI) as the inflation measure for increasing deferred pensions and pensions in payment.

The rules of each scheme required the increase and revaluation to be based on RPI, defined as "the Government's Index of Retail Prices or any similar index satisfactory for the purposes of HMRC".

The issues to be addressed

Questions arose as to the meaning of the definition above. The High Court was asked to determine four main issues:

1)            Does the phrase "or any similar index" allow for an index other than RPI?

The Court held that on balance, the construction of the RPI definition confers the power to select an index other than RPI even where RPI still existed as an official index. This power is not just exercisable in the event that RPI is discontinued or replaced.

2)            Who can exercise the power to select the index – the sponsoring employer or the trustees?

The Court determined that the sponsoring employer and the trustees could select the index jointly. While the sponsoring employer is primarily responsible for the design of the benefits it provides under a pension scheme, it does not follow that it is also entitled to exercise all powers relating to the alteration of benefits. The power of alteration under the schemes is exercisable by Arcadia with the consent of the trustees – it would be odd, therefore, if the power of selection between indices was capable of being exercised by Arcadia alone.

3)            Would CPI be "satisfactory for the purpose of HMRC"?

HMRC no longer approves pension schemes but merely requires that schemes are registered with them. In addition CPI has received Government endorsement (as the measure for statutory revaluation and pension increases). The use of CPI is also unlikely to prejudice HMRC in any way. Based on these findings the Court concluded that there was no reason to suggest that CPI was anything other than satisfactory.

4)            Whether switching from RPI to CPI breaches the restrictions in section 67 of the Pensions Act 1995? (In broad terms section 67 provides that trustees or employers cannot make changes (including rule amendments) that could detrimentally affect the pension rights members have accrued in the past, unless certain conditions are met or the members agree to the changes.)

              The Court approved the decision in Danks v Qinetiq Holdings Ltd (2012) (?link to our April 2012 e-bulletin). In that case, the High Court held that moving from RPI to CPI  for past service did not breach section 67. The only accrued right members had was a right to have their pension increased by either RPI "or any other suitable cost of living index selected by the Trustees". It followed therefore that they had no accrued right to increases on the basis of RPI.

     Arcadia scheme members' subsisting rights are to be determined by reference to the definition of RPI – which includes an ability to switch to any similar index satisfactory for the purposes of HMRC. The switch to CPI would therefore be possible for past as well as future benefits without breaching section 67.

Wedlake Bell comment

The Government endorsed the use of CPI in place of RPI as the statutory standard for public sector pension increases over four years ago. In that time, CPI has filtered through into private sector defined benefit schemes as the statutory standard for both revaluation of deferred pensions and increases to pensions in payment. However, for schemes that do not incorporate these statutory standards, trustees, employers and lawyers alike have been tasked with interpreting rules to see whether the flexibility to switch actually exists. Some schemes have switched to CPI automatically whereas on others, the interpretation of the rules has led to a lot of head scratching as to whether discretion exists to choose between the two measures of inflation. The Arcadia case is an example of that head scratching finding its way to the Courts for guidance.

We are now clear on how certain definitions can be interpreted and schemes with wording similar to those found in Qinetiq and Arcadia cases can rest easy knowing that if push comes to shove, the employers and/or trustees can switch from RPI to CPI without falling foul of Section 67.

However, what we don't have is clarity on how trustees with a discretion to switch should go about exercising such discretion. For instance, what factors should trustees be taking into account in considering the exercise of such a discretion? Fiduciary duties to members, the reasonable expectations of members and of course the financial health of the scheme and the underlying employer covenant all have a part to play in these considerations. Further judicial guidance in this area is likely and we will keep you posted on developments.

In the meantime, legal advice should be sought on any decision to switch inflationary index and Wedlake Bell's Pensions & Employee Benefits Team would be pleased to assist in providing such advice.

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.

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