In the spotlight: Discretionary Increases

Penny Cogher and Harriet Fletcher from the Irwin Mitchell Pensions team explain why the BP Pension Scheme has recently featured in the Pensions press and look at why discretionary increases have suddenly become a hot topic.

In December 2023, BP Pensioner Group announced that it had begun a legal process against senior members of BP management and directors of the BP Pension Fund Trustee, following concerns around the value of members' pensions. Subsequently, and following a debate in Parliament last week, the Pensions Minister, Paul Maynard, has said he will “look closely again” at the dispute between the BP Pensioner Group and the BP Pension Fund. The dispute centres on decisions made by BP and the Pension Fund Trustee in 2022 and 2023 not to award a discretionary increase of 4% to pensions in payment. A decision which, according to the BP Pensioner Group, has led to an 11 per cent fall in the value of the pension in real terms in two years.

What are discretionary increases?

Discretionary increases in pension schemes refer to the additional increases in pension payments that are not legally required but can be awarded by the trustees or employers of the pension scheme. These increases are usually awarded to help preserve the buying power of a pension once it has come into payment and protect pensioner members against the effects of inflation.

The scheme trust deed and rules will usually contain a rule or rules setting out the rates at which pensions will increase once they are in payment. Guaranteed Minimum Pensions (GMPs) are subject to special rules. For other pensions, the statutory legal minimums are:

• an increase each year of Consumer Prices Index (CPI) inflation capped at 5% for pension earned between April 1997 and April 2005, and 
• an increase each year of CPI inflation capped at 2.5% for pension earned since April 2005.

There is no requirement for schemes to provide increases on pension rights accrued before April 1997. While there have been calls for this to change, the Government has committed to its broad principle of not imposing requirements retrospectively.

To avoid potential disputes, trustees and the employer should ensure they comply with the pension scheme’s governing documentation. If in doubt, or if there is a dispute over what the wording means, they should take expert legal advice as what powers there are between employer and trustees over the granting of discretionary increases. British Airways plc and Airways Pension Scheme Trustees Limited went to the Court of Appeal to gain agreement over the scope of their powers.

The legal formalities should also be fully complied with in documenting the granting of a discretionary increase i.e., a formal trustees’ resolution with conflicts properly addressed and dealt with, plus an employer’s resolution also dealing with conflicts, if they arise. This is particularly important where the trustees solely decide whether to grant a discretionary increase and the employer does not agree. Also, any discretionary increase has to benefit from the preservation requirements. 

It is common for trustees to have a duty under their scheme’s trust deed and rules to consider annually whether to provide discretionary increases. Pensions case law has established that a discretion to grant increases is just that – discretionary – and that the granting of an increase even year on year does not make it an as of right increase if it was only discretionary under the scheme’s trust deed and rules. However, such increases should be stated to members as being discretionary increases, so the position is clear.

Why are DB discretionary increases now on the agenda?

Following the September 2022 mini budget, many schemes have moved from deficit to surplus and several are well advanced on their journey to buy-in, buy-out and winding up. Also, once a scheme’s benefits have been fully secured with an insurer, it becomes increasing difficult to change those benefits, including by way of augmentation. In addition, once a scheme has been wound up that brings an end to all discretionary increases. They are not available from an insurer. These factors mean there is a time limited opportunity for members and pensioners to push for discretionary increases.

Why are discretionary increases important?

Discretionary increases are important for schemes that do not provide pension increases for benefits earned before 6 April 1997 in excess of any GMP as this section of a member’s pension has not increased at all since the member retired and certainly not in line with inflation, unlike all other parts of pension benefits.

It is worth noting that if a scheme is rescued by the PPF, the PPF does not provide any increases on pre-6 April 1997 benefits in excess of the GMP, even if the scheme itself provided such increases. This is a source of deep dissatisfaction for affected individuals – many of whom have tried to get this changed by writing to their Member of Parliament. No wonder the PPF is now so well-funded!

What should the trustees and the employer consider when deciding whether or not to award any discretionary increase?

Firstly, they must work out exactly what their powers and the limits to their powers are under the scheme rules and take specialist legal advice for this. 

Secondly, the trustees must consider what impact granting discretionary increase would have on each category of members and on all members as a whole. They can prefer one group of members over another.

Thirdly, the trustees have to act in the members’ best interests. This is usually taken to mean their financial best interests.

They can consider inflation, the impact having no increases on certain benefits might have had over the years, any representations made by the employer, and by the members. They should also look at what impact granting the increases would have on the scheme’s journey to buy out, together with the impact of scheme specific funding, self-sufficiency and the funding level needed to buy out benefits. Additional factors are the strength of the employer covenant, how any surplus on winding up could be used – what powers would the trustees have then to grant augmentations? How near or far away is winding up?

The employer can prefer its own financial interests as long as it does not breach its duties of mutual good faith and confidence between employer and employee and potentially former employee i.e., deferred member/pensioner, when considering what its approach is to the granting of discretionary increases. The ideal scenario would be one where the trustees persuade the employer to agree to the discretionary increases, if possible.

Our experience:

Some schemes already provide very generous benefits including for all pre-6 April 1997 service. Some are also non -contributory. In those cases, trustees are less likely to press an employer to agree to provide discretionary increases although they should always ask and let the employer properly consider the question. For other schemes, especially those that do not provide full pre-6 April 1997 increases, the trustees can be pushing at an open door and the employer can be persuaded to agree to the granting of discretionary increases. It is more difficult for trustees who have the sole discretion, and they need careful expert legal and actuarial advice.

Should the Government look again at the legal requirements regarding pension increases?

While it is good to have all benefits secured through annuities, it may be that there should be a change in the law here. There is no rationale for not giving pre-6 April 1997 benefits pension increases for non GMP benefits, and this should be a requirement before surplus is refunded to an employer. The PPF’s rules should also be changed. The PPF’s excess in funding has partly arisen on the back on not providing pre-6 April 1997 increases for non GMP benefits even where the scheme rules require these increases, and the scheme was funded for them.