There is a requirement to increase pensions in deferment (ie where someone is no longer an active member of the scheme but they are entitled to preserved benefits when they retire in the future) in final salary occupational pension schemes. This must be done in accordance with limited price indexation (LPI). Historically, the legislation governing LPI has provided that pensions in deferment should be increased by the retail prices index (RPI), subject to a maximum of 5%. The Pensions Act 2008 has reduced the required rate of revaluation of deferred benefits by reducing the LPI cap from 5% to 2.5%. This change took effect from 6 April 2009 and is relevant to benefits accrued after that date only. Trustees and employers should decide whether or not to adopt the lower cap and what action, if any, is needed to give effect to their decision.
What action needs to be taken?
Where the revaluation requirements in the Pensions Act 2008 are more generous than those in the scheme rules, then the legislation will take precedence. Alternatively, where scheme rules provide for more generous revaluation than the legislation, then the scheme rules must be followed.
The table below summarises some common revaluation rule scenarios and the impact of the Pensions Act 2008 changes.
should the scheme be amended?
Where, as is commonly the case, the amendment power requires the agreement of the employer and trustees, the employer may wish to approach trustees with a view to implementing an amendment to introduce this potential cost saving. They could argue that where employers have to pay less on deferred member benefits, this may have a positive impact on the security of member benefits generally.
Before making any decision on what action to take, employers and trustees may wish to seek advice on historic inflation data and future predictions from the scheme actuary to assess the potential for saving. In addition, the employer and trustees may wish to discuss with their scheme actuary the effect on future contribution rates where revaluation is reduced.
Where trustees do not have the power to amend their rules to take advantage of this reduction, the Occupational Pension Schemes (Revaluation) Regulations 1991 provide trustees with the power to amend their rules by resolution, but only with the agreement of the employer.
What about consultation?
There was a concern that, if the change in the LPI cap was to be implemented by a scheme, employers would be required to consult with members under the Occupational and Personal Pension Schemes (Consultation by Employers and Miscellaneous Amendment) Regulations 2006. The Consultation Regulations provide that employers must consult if a ‘listed change’ is to be made to a scheme. A change in the rate of revaluation could arguably constitute a change in the basis for determining the rate of future accrual of benefits or a reduction in the rate of future accrual, which are ‘listed changes’.
The Pensions Regulator has confirmed to Eversheds that there is no need for employers to consult before they amend their scheme to reduce the upper limit on the rate of revaluation from 5% to 2.5%. In its view, any such change is being made ‘for the purposes of complying with a statutory provision’ and, therefore, falls under the exclusion in Regulation 10(1)(a) of the Consultation Regulations.
This clarification from the Regulator effectively removes the risk that enforcement action will be taken against employers who do not consult, and its pragmatic approach to this issue is welcomed.
By Ronald Graham, partner, Eversheds LLP. E-mail: ronaldgraham@eversheds.com.