In a significant judgment, the Court of Appeal has upheld a ruling given by the High Court last year. Accordingly, alterations to the rules of salary-related contracted-out pension schemes made between 1997 and 2016 that were not supported by a 'section 37 confirmation' are void even when the alterations were only intended to affect rights to be earned by future service.

Aspects of the judgment and the approach the Court took in construing the relevant regulation are likely to be surprising to some. In any event, employers and trustees of pension schemes across the industry will likely want to consider with their professional advisers the practical implications of the ruling. A number of issues remain unresolved, and it is possible the Department of Work and Pensions will pass regulations to ameliorate the difficult practical position the judgment leaves the industry in.

In the High Court and the Court of Appeal, Gowling WLG (UK) LLP acted for Virgin Media Limited, which argued that the absence of a written confirmation did not invalidate alterations to rights which would be earned by future service.

Background

Before 1997, contracted-out pension schemes enabled employers to pay reduced National Insurance (NI) contributions in exchange for providing employees with a Guaranteed Minimum Pension (GMP). The State would forego a certain amount of National Insurance contributions but would pay reduced State Earnings Related Pension Scheme (SERPS) pensions to employees.

Legislation was brought in which was designed to reduce the risk that employers and employees might benefit from paying reduced NI contributions but that the employees might not receive their GMPs in full when they retired.

In 1997, changes were made to the way schemes could be contracted out on a salary-related basis. The main change was that schemes no longer had to provide GMPs but would have to meet a statutory standard or 'reference scheme test'. Members would accrue their contracted-out benefits instead of SERPS. The responsibility for ensuring that contracted-out schemes met the statutory requirements was placed on the scheme actuary.

The issue

The case concerned a deed that had been executed in 1999 for the National Transcommunications Limited Pension Plan (the Plan) which purported to alter the Plan's rules. No written confirmation has been found from the actuary before the deed was executed confirming that, after the rule alterations were made, the Plan would continue to meet the 'reference scheme test'.

Virgin Media Limited, the Plan's employer, accepted that, in so far as the alterations were intended to make changes to benefits that had already accrued by service before the deed, those alterations were not effective because of the fetter in the Plan's power of amendment.

The question for the Court of Appeal (and the High Court last year) was whether the absence of a written confirmation rendered void alterations it was intended to make to benefits that would be accrued by future service after the deed had been executed.

This issue boiled down to what constituted "section 9(2B) rights" for the purposes of Regulation 42 of the Occupational Pension Schemes (Contracting-out) Regulations 1996. In particular, did a benefit that would be earned by future service fall within the expression "accrued rights to pensions", which was the relevant part of the definition of "section 9(2B) rights" for the purposes of Regulation 42?

The decision

Of the three that made up the Court of Appeal panel, two judges specialised in pensions when they practised at the Bar, Lord Justice Nugee and Lady Justice Asplin.

In a much-awaited judgment, the Court of Appeal concluded that the definition of 'section 9(2B) rights' included both past service rights and rights to be earned by future service. The effect of that conclusion was that, to be valid, any alteration to the rules of a contracted-out scheme between 1997 and 2016 must have been supported by a 'section 37 confirmation' from the actuary, even if the alteration was only intended to affect future service rights.

The approach the Court of Appeal took

Virgin Media Limited argued that the expression "accrued rights to pensions" was not apt to include benefits to be earned by future service.  This was because, at the time the alteration was made, the member had no 'right' to the benefit, still less an "accrued right" to it. In the pensions world, the expression 'accrued right' has a particular meaning.

Looking at the word 'rights', Lord Justice Nugee considered that this "very general word" could apply to rights "already earned or yet to be earned". Giving a practical example, the learned Judge thought it an "entirely natural use of language" to say that an employee has a right to the payment of next year's salary provided he or she continues in employment and that, if the employer seeks to reduce the employee's salary the following year, that would constitute an attempt to take away his or her rights.

That conclusion might be thought surprising and its implications outside the current context might need to be thought though.  Be that as it may, perhaps even more controversial was how Lord Justice Nugee construed the words "accrued rights".

The learned Judge acknowledged that the company was on "considerably stronger ground" in arguing that the expression “accrued rights” refers to those rights already earned at a point in time. Indeed, Lord Justice Nugee agreed with that as a general proposition and accepted that, if you ask what at any particular date a member’s accrued rights are, the "obvious answer" is those that have been earned by service to date – in other words their then past service rights.

However, Lord Justice Nugee thought that, in construing the words 'accrued rights' it was necessary to have regard to the purpose of the legislative and regulatory regime, which he thought was intended to encompass alterations to benefits to be earned by future service.

In his judgment, the learned Judge acknowledged that, at the hearing of the appeal, Counsel for the Representative Beneficiary had not found it easy to articulate how his interpretation of the expression 'accrued rights' could be squared with its ordinary meaning. Lord Justice Nugee accepted that interpreting the words to include rights to be earned by future service seemed "an unusual use of the expression"' which involved an "apparently paradoxical submission". 

However, the learned Judge thought that the conclusion that the words "accrued rights to pensions" included rights that would be earned by future service was "not … impossible" and that was the conclusion the Court reached.

It is well known that the process by which you interpret legislation can be purposive and informed by the context in which the legislation was introduced. Yet, it is likely to be somewhat surprising to some that the Court felt able to go as far as it did here. The Court's approach may be contrasted with the approach that is taken when construing scheme documents, for example, pension deeds, when a more literal approach is often adopted.

Unresolved issues

A number of industry-wide issues remain unresolved by the Court of Appeal's judgment, including:

  • What counts as a written actuarial confirmation for the purposes of Regulation 42? Could, for example, a confirmation be made in an email (and, if so, what degree of formality would be needed) or by a reference in an agreed set of Trustee minutes?
  • Would a recertification of a pension scheme's contracted-out status in the triennial valuation after an intended alteration validate the alteration, whether from the date of the alteration or the date of the recertification?
  • What evidence would be sufficient to take a view that on balance of probabilities a confirmation had been provided in relation to an intended alteration?
  • Precisely what alterations to the rules of an affected scheme would need to be supported by a section 37 confirmation?

Trustees and employers should take legal advice on the steps, if any, that they should take in light of the judgment.

The pensions industry is also waiting to hear whether the Department of Work and Pensions will make regulations to ameliorate the difficult practical position that the judgment leaves the industry in, noting that section 37(2) of the Pension Schemes Act 1993 specifically envisages that regulations may be made to validate retrospectively any rule alteration which would otherwise be void under section 37.

In the meantime, the industry continues to grapple with the practical consequences of this judgment.

To discuss this ruling or any of the points raised in this article, please contact Ian Gordon.