Governance

Pension schemes can't just switch to CPI

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Governance
Written by Roberta Murray   
Monday, 19 July 2010

Aon urges Government to adopt an informed and considered approach ahead of implementation on new pension rules.

 

Government proposals to lower the cost of providing defined benefit (DB) pension schemes for employers, by linking the statutory minimum increase to the consumer prices index (CPI) instead of the retail prices index (RPI), could have the opposite effect for as many as 3 in 5 schemes, according to Aon Consulting, the employee risk and benefits management firm.
 

A survey of 80 pension schemes by Aon, showed that 58% of schemes are required by their rules to increase pensions in payment by reference specifically to the RPI, and 15% have the same restriction for deferred pensions.

Those schemes are prohibited from simply switching to CPI by existing pensions legislation (the Pensions Act 1995 introduced a prohibition on making detrimental changes to accrued benefits).

Therefore they are unlikely to be able to take advantage of the new legal minimum unless legislation is amended alongside the change to the legal minimum increase. 

If such legislation isn’t changed then CPI will become the new legal minimum, and pension schemes will effectively find themselves required to award the higher of the two measures – RPI by the scheme rules and CPI by the legislation.
 
Overall, Aon welcomes the new proposals but believes that the impact of such changes could vary considerably depending on the specific wording of scheme rules.  The firm urges the Government to consult thoroughly with the industry prior to the implementation.
 
Aon’s findings showed that:
 
  •  Over half (58%) of schemes link pensions in payment specifically to RPI, so may not be able to take advantage of the changes proposed by the Government.  Around 1 in 7 (15%) of schemes link deferred increases specifically to RPI and will face similar challenges.
 
  • 79% of schemes define deferred increase by reference to the legal minimum, while 20% of schemes define pension increases in payment by reference to the legal minimum.  These schemes will likely change to CPI indexation by default.
 
  • 22% of schemes link pensions in payment to RPI but have the flexibility to select an alternate measure if the Trustees and/or Company so determine.  These schemes will therefore need to consider how to react to any change.  6% of schemes have this flexibility in relation to deferred increases.
 
Paul McGlone, principal and actuary, Aon Consulting said,

“Overall we believe that CPI is a more appropriate measure of inflation than RPI when considering pension increases, and combined with the fact that many schemes remain under substantial financial pressure this has to be a welcome move.  However, the success of such reform will hinge on the legislators understanding the implications for every kind of scheme, and ensuring that schemes are not left out simply because they have a particular type of wording in their rules.  For instance, our survey data shows that 3 in 5 schemes won’t be able to take advantage of the proposals set out by the Government unless some form of legislation accompanies the change to the legal minimum.
 
“Even if the legislation is enacted thoughtfully, there will remain challenges.  As far as we are aware, this is the only example of pensions legislation which has deliberately acted to reduce (or permit reductions in) private sector pension benefits retrospectively.  Schemes may therefore be cautious in making these changes, and will want to ensure that they avoid legal action being taken by their members.” 

 
 
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