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A transport firm and its pension trustees failed to convince the Court of Appeal that the consumer price index should be used for inflation increases, after a member and former trustee had successfully challenged the switch through the Pensions Ombudsman.
The question of whether a particular scheme’s rules provide for inflation increases to be in line with the retail price index or CPI – with the potential cost savings attached to this – continues to be brought all the way to court, despite the low success rate of such cases: only a handful of companies where the issue was contested, including Qinetiq and Arcadia, have been allowed to switch thus far.
Judge dismisses appeal
In March this year, transport and defence giant Thales UK appealed a Pensions Ombudsman determination from last December, when ombudsman Anthony Arter found that the Thales UK Pension Scheme trustees had wrongly changed the rate of increase to CPI.
Mr Justice Nugee backed the ombudsman in his interpretation of the scheme rules. Using CPI to measure inflation would have made a difference of about £20m to the scheme liabilities.
The appeal hinged, as it normally does in these cases, on the exact wording of the rules, which were ambiguous. The relevant sentence explicitly mentions RPI, but also a section of law which now refers to CPI.
Having stuck with RPI for some years after CPI became a statutory inflation measure, in 2016 Thales UK took legal advice which found that the scheme could switch to CPI. The trustees in turn sought help from a leading counsel, who came to the same conclusion. In early 2017, they informed pensioners that the change would be made in April that year.
Employer and trustees were in agreement
The case is unusual because the trustee and employer were in agreement after taking legal advice, but it was a scheme member who was not, said Arron Slocombe, a partner at law firm Baker McKenzie. Often the trustees or employers ask the High Court up front for a direction on how the rules apply.
The Thales UK case shows how nuanced the court's analysis can be, he said. “Trustees and employers might well say, ‘If QCs agree, then surely that is enough?’ Well, not if a member complains successfully,” said Slocombe.
Thales follows another CPI/RPI case between Atos IT Services UK and its pension schemes in January. More such cases are expected to go to court, but Slocombe said he is not seeing quite as many queries now. “I think it is fair to say that employers seeking [to move away from] RPI have had a poor run in the courts,” he noted.
For an employer to contest the use of RPI now “would probably need a clearly different form of rule to test before the courts – and there are still untested formulations out there – or significant money riding on the outcome to justify a trip to court”, he believes.
Sponsors could challenge the accuracy of rules
Employers could however try a different approach, Slocombe suggested, by contesting not how the scheme rules should be interpreted but arguing that they were wrongly drafted and should in fact have referred to the statutory minimum, which is currently CPI.
“I know of at least a couple of schemes where there must be a reasonably good chance that the employer and trustees at the time intended the rules to require only statutory minimum... but which inadvertently hard-coded RPI,” he said, believing that the court would grant rectification where the evidence is strong – as in the recent case of Univar v Smith.
“Testing whether the rules state RPI by mistake could, and for some employers seeking CPI should, be an investigation worth making,” he said.
Will Covid-19 prompt more employers to request CPI?
For now, most employers still seem to stumble across the issue in a less strategic way. Although the question of whether to use RPI or CPI has been around since 2011 when CPI became the statutory rate of increase, “employers come to it in different ways and at different times”, often depending on their economic situation, said Sackers partner James Bingham.
So far there has not been an upturn in interest brought about by the Covid-19 crisis, but he said it would be unsurprising if, after a valuation, more employers were to develop an interest in inflation increases.
However, in most cases the courts decided that RPI must continue to be applied, so why do employers still agree to incur the legal cost of going to court?
There will always be a cost/benefit analysis preceding the decision to pursue an index change, explained Bingham, and the extent of any ‘upside’ from winning will play a role, as legal expenses are the same regardless of the potential cost saving.
“Even for a case that has a less than 50% chance of success you might still think it’s worth the attempt if the upside is big enough,” he said.
But the level of uncertainty is high, as the outcome relies entirely on how a particular judge views the wording of a scheme’s rules, in line with the legal principle of construction.
Trustees should consider strength of legal advice
With most cases going against CPI, trustees who are approached by their sponsor about switching to CPI where the rules are not clear should be cautious to exercise their power, as this could be challenged later by members.
“At least insist on getting counsel’s opinion or a court’s view on this before you exercise it,” said Bingham. However, there is no guarantee of safety. The Thales trustees had sought legal advice before a judge decided this advice was wrong.
Much depends on how strong the advice is. “If they get very strong advice that this is how it should be construed, they can act on this,” Bingham opined, while any hint that the rule could potentially be viewed differently should be seen as a red flag.
As the government has proposed to align RPI with CPIH – an index more in line with CPI – between 2025 and 2030, there could be fewer of these cases in future; but this still leaves up to 10 years of RPI increases, and it is unclear at this point how the change will be implemented in practice for pension funds.
“We'll have to see what those changes are in due course and then work through what the effects might be,” said Bingham.
Has your scheme been approached about a switch to CPI?