The Chancellor of the Exchequer announced in the Budget statement on 22 June that, with some exceptions (notably the state pension and pension credit), from next year consumer prices rather than retail prices will be the basis for uprating most benefits and public sector pensions. The Government has now gone further: in a Statement yesterday, Minister for Pensions Steve Webb said that it intends to use the Consumer Price Index (CPI) as the basis for determining increases for all occupational pensions as well as payments made by the PPF and FAS.

This will apply to defined benefit occupational pension schemes in reckoning

• revaluation of the excess over GMP for deferred pensions coming into payment;
• increases to post-88 GMPs in payment; and
• LPI indexation of pensions in payment (attributable to post-97 pensionable service).

In addition, some money purchase schemes which have to comply with the LPI legislation because they are paying pensions which started before 6 April 2005 will also be affected.

To achieve this no change will be required to the key legislation in the Pension Schemes Act 1993 (paragraph 2 of Sch 3, as amended by s.101 & Sch 2 PA 2008), as this simply refers to "the percentage increase in the general level of prices". This is also true of s.109 of the same Act which governs GMP increases. Up to now, "the general level of prices". has always been taken to refer to the Retail Prices Index (RPI); from next year the Government will use the CPI* instead.

* Aries comment

The ONS website offers many variations of the CPI depending on what is included or excluded. We are assuming for now that the Government will choose the one labelled D7BT (CPI All Items; 2005 = 100, monthly series).

However, the Government will have to amend legislation to enable CPI to be used for relevant increases in respect of the PPF (PA 2004 Sch 7 para 28) and FAS (SI 2005/1986 Reg 17(13) as inserted by SI 2010/1149 Reg 8(d)), because there the RPI is specifically prescribed. The Minister said he will bring these amendments before Parliament at the earliest opportunity.

For the same reason, occupational pension scheme trustees wishing to switch from RPI to CPI will have to amend their scheme rules, where these prescribe use of the alternative LPI provisions in PA 1995 s.51 (3)-(4). Even where the scheme follows the Revaluation Order, if the rules specifically refer to RPI they might need amendment. A statutory override might avoid this, but there is no indication at present that the Government plans to include such a provision.

The move will save schemes money (figures as large as £100bn are already being quoted in the pensions press), because as CPI excludes housing costs and council tax, it is usually lower than RPI. Pensioners are less likely to still have a mortgage, so the CPI basis is being presented as better attuned to the effect of inflation on this age group. However, from time to time - as during the whole period from September 2008 to December 2009, for example, when mortgage interest rates were low and steady - CPI is higher. Over the longer term, though, CPI has been about 0.5% lower, so it is most likely that in future, pensioners' income in retirement will be lower than it would otherwise have been. Using official figures for CPI and RPI over the last twenty years, the TUC has calculated that an eighty year old pensioner on the average public sector pension of £5,500 who has been retired for twenty years would now have a pension of £4,845 a year - 12 per cent or £655 less - if CPI uprating had been in force since their retirement. It is unclear whether and to what extent, if any, the new basis and legislative amendments are to be made retrospective.

If trustees who have been using RPI switch to the CPI basis, there are going to be communications issues, especially if members have been told in the past that RPI-indexation would apply. If conversely, the RPI basis is retained in the scheme rules, a CPI-based calculation will have to be done as well, just in case it produces a higher figure one year.

Funding questions arise, too. While lower costs for the sponsor grab the headlines, trustees may not find it so easy to match assets to the liabilities, unless the Government can deliver gilts index-linked to the CPI instead of or as well as the traditional RPI-linked gilts. Investment costs might therefore be greater.

There are also questions around section 67 (PA 2004 s.262), under which a modification of an occupational pension scheme which

"would or might result in a reduction in the prevailing rate of any pension in payment under the scheme rules"

is a "protected modification", and subject to the informed consent requirement.

Update 21 July

The Pensions Regulator (TPR) has this week published a brief statement on the Consumer Prices Index intended to assist trustees and employers in managing the impact of the proposed changes, and to outline how TPR will deal with this issue. Once changes - including any legislative provisions - are finalised TPR will expand this guidance.

This follows a statement issued by the DWP on 12 July, amplifying the Ministerial Statement of 8 July reported above. This makes it clear that RPI will continue to be the basis for calculating deferred pension increases up to September 2010, and CPI thereafter.

Steve Webb provided answers to some anticipated questions in a subsequent briefing (which included the DWP Statement) to MPs on 14 July. Addressing the question of a statutory override, the Minister wrote

"The Government understands the issues facing schemes that have RPI written into their scheme rules and we will consider the case for a statutory override for these schemes. However we need to think carefully about the options for how any override would operate or whether, indeed, this would be the best way to address the issue because we need to balance protecting pensioners' incomes with the need to ensure that schemes remain viable for companies."

The Minister's latest statement on the subject was made to Parliament on 19 July (ie two days ago):

"Miss Anne Begg (Aberdeen South) (Lab): In a written statement, the Minister said that the Government would force occupational pensions to be linked to the consumer prices index instead of the retail prices index. What powers do they have, or will they have, to take to make that happen?"

"Steve Webb: I am grateful to the Chair of the Select Committee on Work and Pensions for her question, as this matter has not been well understood. Statute provides a floor above which occupational pension schemes have to operate. In other words, we will not force occupational pension schemes to cut their increases; we simply provide a floor, which used to be linked to the RPI and is now linked to the CPI. Schemes remain entirely free to go beyond that if they wish."