A recent determination by the Pensions Ombudsman[1] has provided further clarity on the boundaries of employer discretion in defined benefit pension schemes, specifically regarding discretionary pension increases. The case, brought by Mr Y against Smiths Group plc (the Employer), examined whether the Employer’s decision not to request the trustee to award a higher discretionary increase in pensions breached its duty of good faith.
Background
Mr Y, a member of the Smiths Industries Pension Scheme, challenged the Employer’s approach to pension increases in 2022. The scheme’s rules, updated in 1998 and 1999, included an “aim” to provide annual increases in line with the Retail Price Index (RPI), capped at 10% and “subject to the finances of the scheme”. However, the rules also made clear that increases above 5% were at the Employer’s discretion, requiring the Employer to “have regard” to the stated aim when making its decision.
In May 2022, despite the RPI being above 5%, the increase applied to pensions in payment was capped at 5%. Mr Y argued that this fell short of the commitments made to members by the Employer and breached the Employer’s duty of good faith between an employer and an employee (the so-called Imperial duty).[2]
The complaint and arguments
Mr Y’s complaint centred on the expectation – rooted in a 1998 newsletter and subsequent rule changes – that annual increases would match the RPI up to 10%, unless scheme finances dictated otherwise. He contended that:
- the stated aim was more than a discretionary benefit – it was a substantial enhancement to member benefits;
- the Employer’s discretion should not amount to a veto and the “subject to the finances of the scheme” wording was not intended to give unfettered power; and
- the Employer’s refusal to request the trustee to award the higher increase was inconsistent with the “bargain” struck at the time of a merger in 1998 and breached the Imperial duty.
The Employer, for its part, maintained that the stated aim was a discretionary benefit rather than a contractual promise. The Employer argued that it had acted in accordance with the scheme’s rules, including the requirement to “have regard” to the stated aim, and had fulfilled its duty of good faith. In making its decision not to request a higher increase in 2022, the Employer stated that it had considered the scheme’s finances and other relevant factors, such as the long-term financial security and resilience of the scheme for all members.
The Pensions Ombudsman’s determination
The Ombudsman dismissed Mr Y’s complaint, concluding:
- there was no absolute commitment to pay increases above 5% – the Employer had discretion, albeit “constrained” by the requirement to have regard to the stated aim and scheme finances;
- the phrase “subject to the finances of the scheme” was deliberately broad and the Employer was entitled to weigh multiple factors, including long-term scheme security;
- the Employer had not breached its duty of good faith. In exercising a non-fiduciary discretionary power, the Employer could consider its own interests alongside those of scheme members; and
- the decision was not irrational or perverse, and the Employer had genuinely considered the relevant factors.
The Ombudsman also noted that, while members may have had expectations based on past communications, such expectations do not override the scheme’s rules or the Employer’s discretion. However, the Employer must continue to consider the issue afresh in any future year where inflation exceeds 5% and cannot simply decide never to grant higher increases.
Key takeaways
- Discretionary increases: Where an employer has discretion to grant increases above a set cap, this discretion must be exercised in accordance with the scheme rules.
- Duty of good faith: An employer’s duty is to act rationally, for a proper purpose, and taking into account all relevant factors. There is no requirement to prioritise member interests over all others.
- Future considerations: An employer must not fetter their discretion and must genuinely consider the possibility of higher increases each year, where relevant.
Conclusion
This determination reinforces the principle that discretionary pension increases remain just that – discretionary – unless the scheme rules provide otherwise. Employers must exercise their discretion properly, but are not bound to grant increases simply because members expect them. The case is a useful reminder for trustees, employers and members alike to pay close attention to the precise wording of scheme rules and the legal limits of employer discretion.
[1] https://www.pensions-ombudsman.org.uk/sites/default/files/decisions/CAS-99766-L5X6_4.pdf
[2] Imperial duty refers to the implied duty of an employer to act reasonably and not destroy or seriously damage the relationship of trust and confidence between the employer and employee.
