House of Commons Library

Occupational pension increases

Published Thursday, October 26, 2017

Looks at the requirements on private sector Defined Benefit occupational pension schemes to index and revalue pension benefits and recent debates - including the British Steel Pension Scheme and the 2017 Defined Benefit Pension Scheme Green Paper

Jump to full report >>

Defined Benefit (DB) pension schemes provide pension benefits based on salary and length of service. There are statutory minimum requirements on them to:

  • Index pensions in payment in line with inflation, capped at 5% for benefits accruing from service between April 1997 and April 2005, and at 2.5% for benefits accruing from April 2005 - known as Limited Price Indexation (LPI) (Pensions Act 1995, s51);
  • Revalue the deferred pensions of early leavers in line with inflation capped at 5%, and at 2.5% for rights accrued on or after 6 April 2009 (Pension Schemes Act 1993).

Before April 1997 there was no general obligation on Defined Benefit schemes to increase pensions in payment (although there was a requirement on schemes that were contracted out of SERPS to provide indexation capped at 3% on rights accrued from 1988).

Importantly, these are statutory minimum requirements -there is nothing to prevent schemes from making more generous arrangements through their scheme rules. Despite the fact that indexation was not made mandatory for rights accrued before 1997, it appears that many schemes did apply some form of inflation protection to pensions in payment on a voluntary basis and many applied LPI retrospectively to service before 1997 (Deregulatory Review, March 2007)

Development of the rules

In 1993, the Pension Law Review Committee, chaired by Professor Roy Goode, recognised the importance of indexation from the individual’s perspective:

  • Most important is the uncertainty with regard to inflation. The individual is concerned not with money amounts but with what the pension will buy.(Pension Law Reform. The report of the Pension Law Review Committee, para 3.1.10)

Despite this, the Committee did not recommend making LPI retrospective, because it:

  • […] recognised that to require all earnings-related schemes to introduce LPI for pension rights accrued before the appointed date would place a considerable burden of costs on such schemes. (Ibid)

The Labour Government legislated to reduce the LPI cap to 2.5% for rights accrued from April 2005 in the Pensions Act 2004 (s278-9). Following a consultation, it had decided that “mandating some level of protection from inflation remains desirable” but that lower inflation levels made a reduction in the cap appropriate:

  • In 1995, when the legislation introducing LPI was passed, long-term expectations of inflation were significantly higher: the 5 per cent cap was only intended to provide for partial cover against inflation. But the Government’s success in reducing inflation means that mandatory indexation has effectively become full inflation cover, something which is proving disproportionately expensive for some schemes to provide. (Cm 5835, p23).

In December 2006, an independent review looked at whether LPI should be removed. However, the reviewers – representing the employer and union sides - were unable to agree.[3] The Labour Government decided not to remove the requirement on the grounds that it was an important protection for members and there was no clear evidence that removing it would have a direct and significant effect on employer provision (Deregulatory Review, March 2007).

From April 2011, the Coalition Government changed the measure of inflation used for determining the annual minimum increases from the Retail Price Index (RPI) to the Consumer Prices Index (CPI) (HC Deb, 8 July 2010, c14-16 WS).The change was controversial because the CPI inflation tends to be lower than RPI inflation. The impact of the legislative change on individual schemes would depend on what their rules said (DWP, Impact assessment, 12 July 2011).

Recent debates

In its December 2016 report on Defined Benefit pension schemes, the Work and Pensions Select Committee said schemes that had latitude in their rules to switch to the CPI had tended to do so. It recommended that the Government consult on “permitting trustees to propose changes to scheme indexation rules in the interests of members”:

Pension promises are just that. Any change to the terms of them should not be taken lightly. In circumstances where an adjustment to the scheme rules would make the scheme substantially more sustainable, however, a reduction in benefits could well be in the interests of members.

In a Westminster Hall debate on 17 January 2017, concerns were raised about the impact of non-indexation of pre-1997 rights on pensioners. MPs called for the Government to address the issue in its forthcoming Green Paper on defined benefit pension schemes. Pensions Minister Richard Harrington said the Government believed that “retrospectively changing the legislative requirements on indexation would be inappropriate and would have a significant impact on the schemes of employers involved.” (HC Deb 17 January 2017 c270-284).

In its February 2017 Green Paper, the Government asked for views on whether:

  • There was evidence to suggest an affordability crisis that would warrant permitting schemes to reduce indexation to the statutory minimum;
  • The Government should consider a statutory over-ride to allow schemes to move to a different index, provided protection against inflation was maintained;
  • The Government should consider allowing schemes to suspend indexation in some circumstances. (DWP, Security and Sustainability in Defined Benefit Pension Schemes, CM 9412, Feb 2017).

 British Steel Pension Scheme

In May 2016, the current Government launched a public consultation on the British Steel Pension Scheme (BSPS), which included a proposal to allow the scheme to reduce indexation and revaluation on future payment of accrued pension rights. To do this, they would need to change the ‘subsisting rights provisions’ which prevent unilateral changes to members benefits in a way that is detrimental to members’ rights in the scheme (Pensions Act 1995, s67). The scheme trustees argue that the proposals are in the best interests of the Scheme membership. However, some commentators expressed concern at the wider implications of undermining the principle that pension promises, once made, cannot be changed retrospectively.

On 16 May 2017, the Pensions Regulator (TPR) reported that the key commercial terms of a Regulated Apportionment Arrangement had been agreed in respect of the BSPS. It would continue to work with Tata Steel UK and the trustee “in respect of the proposal to offer members an option to transfer to a new scheme sponsored by TSUK, which may occur should the approval to the RAA be granted, or stay in the BSPS and receive PPF compensation” (TPR, Statement on British Steel Pension Scheme, 16 May 2017).

On 11 August 2017, TPR said it had given initial approval to a proposal from Tata Steel UK to restructure the BSPS:

This restructuring will be done through a regulated apportionment arrangement (RAA). The BSPS will receive £550 million from the Tata Steel Group, significantly more than it would receive in insolvency, and a 33% equity stake in TSUK.

Following completion of the RAA, the scheme will offer members the choice to either transfer to a new scheme (if it meets certain qualifying conditions) which will be sponsored by TSUK, or remain in the existing scheme which will transfer to the PPF. (PN17-48, 11 August 2017)

The deal received formal approval from TPR on 11 September 2017. Scheme members have until December to choose between two options:

Information for scheme members is at: www.bspensions.com/choose

Chair of the Work and Pensions Committee Frank Field has written to TPR raising questions about the indexation arrangements in the new scheme.

 

 

Commons Briefing papers SN05656

Author: Djuna Thurley

Topic: Pensions

Share this page

Stay up to date

  • Subscribe to RSS feed Subscribe to Email alerts Commons Briefing papers

House of Commons Library

The House of Commons Library provides research, analysis and information services for MPs and their staff.