Government acted lawfully in changing measure of inflation for public sector pensions, court says

In a majority judgment (39-page / 368KB PDF), Lord Justice Elias said that it would have been "remarkable" if Parliament had intended to exclude "any price index which attracts widespread support from professional economists in the field" from consideration as a measure of inflation.

"If it appears to the Secretary of State that [CPI] is a proper way to ensure that pensions retain their value, without pensioners receiving either too much or too little, we can see no reason why he should not adopt that index," he said.

However all three judges agreed with the unions that the change was intended as a deficit reduction measure rather than a genuine belief that CPI was a more appropriate measure of inflation for pensioners than CPI as the Government had claimed.

Mr Justice McCombe, dissenting, said that this made the switch unlawful.

"The obligation is to conduct the review to determine whether benefits have retained their value; it is not to find a method that will produce savings and then see whether it can be said properly to measure the relationship between the benefits and prices," he said.

The Government changed the measure of inflation in public sector pensions from the RPI to the CPI in April 2011 after announcing the switch in the 2010 budget. However six unions including the Public and Commercial Services Union (PCS), UNISON and Unite claimed that, because CPI inflation is around 1.2% lower on average than RPI inflation, the resulting loss to existing public sector pensions would be around 15%.

They said that the imposed change was not permitted under social security legislation, which requires the Government to adjust benefits according to the "general level of price increases" each year. The formula for calculating CPI includes the spending behaviour of people more likely to switch to cheaper alternatives as prices increase, including pensioners and students in halls of residence.

In it judgment, the High Court said that under the previous calculation public sector pensions would have increased by 4.6% this year. Under CPI, the increase was only 3.5%.

John Hanratty, a public sector pensions expert with Pinsent Masons, the law firm behind Out-Law.com, said that the decision turned a part of the public versus private sector pensions debate prompted by recent strike action on its head.

"Many private sector schemes have RPI 'hard-wired' into the documentation of the scheme so it cannot be changed for rights accrued. This means that in some, although not all, private sector schemes, pension increases will be more favourable than those in the public sector," he said.

"However, coming on top of proposed cuts in accrual rates for public service pensions, increases in contribution rates and a two-year pay freeze followed by a cap on the increases of public servants' pay, the package does hit quite hard the middle and lower earners who work in the public sector and questions will continue to be raised about whether the lower-paid continue in membership of the public service schemes," he said.

Although public service pension schemes are currently cash-flow positive for the most part, Hanratty said that enough lower earners deciding it was no longer worth investing in a pension scheme could result in significant disinvestment from the schemes over the medium term making it more difficult for the Treasury to fund them.

He stressed that, although the judgment supported the Chancellor's position it was only one piece in the "larger jigsaw" of public service pension reform.

"Most people accept a need for sensible reform to ensure that the schemes are sustainable and fair into the future. As I have said consistently throughout the reform process, communication is key." he said.

A spokesperson for Thompsons Solicitors, the firm which acted for the six unions, said that the unions intended to appeal.

"While the High Court's split ruling is disappointing, the unions are pleased that their main argument, that the chancellor was motivated by deficit reduction when he made the switch, was accepted. It is encouraging that one judge agreed this was illegal," the spokesperson said.

"At a time when public sector employees are being forced to bear the burden of the financial crisis, the unions will not allow this unfair and, in our view, unlawful breach of the contracts of millions of workers to rest."