Discretionary increases in focus as inflation hits 9.4%
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As inflation continues to rise, should pension trustees consider increasing pensions in payment by more than the minimum?
Inflation has climbed further amid sky-high fuel and oil prices. The consumer price index has risen to 9.4% in June, from 9.1% in May, while the retail price index is already at 11.8%. As inflation is felt through energy bills and groceries, it affects pensioners, so should trustees go beyond minimum increases?
Increases are complex and may not apply in the same way to all members. As well as knowing whether the scheme rules prescribe RPI or CPI for a particular tranche of the membership, there are different statutory minimum increases depending on the accrual period. Pensions relating to service before 1997 do not need to be uprated, although many schemes do so voluntarily, while a minimum increase of 5% CPI applies for service between April 1997 and April 2005, and 2.5% CPI for service after April 2005 – well below the current levels of inflation.
While it may be tempting for trustees to grant increases, doing so without the sponsor’s approval can be costly. The trustees of the British Airways Pension Scheme settled with the airline in late 2019 after a court battle lasting six years over discretionary increases, bringing inevitable legal fees.
Increases are an emotive issue
Dinesh Visavadia, a director at trustee firm ITS, said the issue of pension increases is very emotive because it affects people’s livelihoods.
Trustees cannot reasonably ask for discretionary increases if the scheme is in deficit as it will worsen the security of benefits without additional contributions, he opined. Even where there is money, “it is a difficult call to decide how to use the additional funds - improve member security of promised benefits or award discretionary increases".
A further complication can arise through reputational risk, which can be difficult to manage even when there is a deficit. “Public companies that provide services to the government could be in this situation where it can be argued that the funding for such services does not properly reflect the funding of pensions,” he observed.
For the current situation, Visavadia advised trustees to wait and see: “It is a little early to consider discretionary increases. Until there is evidence of sustained inflation embedded in the economy, there is little immediate action to take.”
Although inflation eats away at the real value of pensions in payment, Visavadia also pointed out that there is some benefit from high inflation for deferred members coming up to retirement age, as it can result in a higher revaluation of their pension.
Trustees should understand which factors are relevant
Due diligence is paramount if trustees decide about discretionary increases, stressed Jeanette Holland, a partner at law firm Baker McKenzie. This includes understanding whether the relevant tranche of members are pre or post-1997, what the rules say about discretion, where the power to grant increases sits between trustees and employer, and an awareness of past scheme practice.
“Given the potential cost implications from increases that are awarded, it’s worth getting the basic governance correct,” she said speaking at a webinar on Tuesday.
Part of any exercise should include a look at the way in which past decisions have been recorded in minutes and communicated to members, she added. Recording decisions and the process by which they are arrived at is important, as they frequently need to be looked at afresh, she said.
Trustees should also make sure they have any relevant information from their advisers, “so that the groundwork is done” by the time they take a decision, Holland noted.
Can you give increases to one group but not another?
Pension schemes often contain many different membership and benefit tranches, so do discretionary increases have to apply across the board?
Speaking at the same event, Baker McKenzie partner Jonathan Sharp said the key is to understand which factors are relevant to consider and which are not, and that the decision is arrived at in a way that is reasonable.
This issue came up in the 1999 Edge v Pensions Ombudsman case, Sharp noted, where trustees granted service credit to current but not to former employees or pensioners. “The court upheld that it was valid given the process they’d been through,” he explained, adding: “Acting fairly is not the same as saying everyone must be treated in the same manner."
