With cost-of-living increase at a 40-year high, trustees are considering whether increases to pensions in payment are sufficient and what, if anything, they can do.
Whose decision?
The starting point, as always, is to check the rules of the pension scheme. For benefits accrued since April 1997 schemes are required to increase pensions to a minimum extent. Frequently the rules will also include a power for either the trustees or scheme sponsors to increase pensions in payment each year to an amount greater than prescribed in the rules. Working out who has the power to award a greater increase and what exactly that power requires is a key initial step.
Trustees may be required to review pensions in payment, from time to time, and grant additional increases to all or any pensions, at their discretion. This does not require the trustees to award increases above those provided for in the rules but does require there to be a review from time to time. Fairly commonly, the scheme’s sponsor will have a role, particularly in relation to cost.
The right approach
The trustees will need to consider the “proper purpose” of the power they have been given. We think this purpose can be summarised as a power to facilitate a catch up of increases where pensions have lost purchasing power because of the caps on guaranteed increases. Keeping this purpose in mind, the trustees would then adopt the following process:
- consider all relevant factors;
- ignore irrelevant factors; and
- reach a decision that is reasonable and not perverse.
If this approach is followed, the courts will not interfere with the decision made.
Possible relevant factors
What will comprise “relevant factors” depends on the circumstances. However, we have given some thought to what might be included:
- Funding and cost – consider the funding of the scheme on differing actuarial bases to understand the impact of an additional increase and the “cost” on each basis. Will an additional contribution be required? If so, this will most likely change the dynamics of the discussion with the scheme’s sponsor.
- Covenant – should the trustees decide to award an additional increase, if within their power and there is funding to do so, the funds needed will not be available in the future should the funding position deteriorate. This may result in an extra “strain” on the scheme sponsor. Also, additional increases create additional liabilities to be supported.
- Comparison of guaranteed increases versus inflation/cost of living increase – what measure of inflation do the rules require for guaranteed increases? Are there reasons to consider an alternative measure?
- View of the scheme’s sponsor – even though the power to grant additional increases to pensions in payment may rest solely with the trustees, it is appropriate for them to seek and consider the views of the scheme’s sponsor; their views are a relevant factor in the trustees’ own decision-making. There may be a separate decision to be made if an additional contribution is required.
- Options – analysis of how different pensioners have been impacted by guaranteed increases i.e. have some pensioners suffered a greater “loss” in purchasing power since retirement when compared to others. There is no requirement to award the same (or any) additional increase to pensioners. It may be that evidence suggests that taking a different approach to different tranches of member is appropriate. Provided that the trustees approach the decision-making in a robust manner, they cannot be criticised for the decision they make.
- Linked with funding, cost and covenant considerations, the impact that granting discretionary pension increases may have on other categories of member, e.g.deferreds.
For further information, please contact:
Lorna Mitchinson, Linklaters
lorna.mitchinson@linklaters.com
