Articles - Issues Arising from Pension Scheme Closure

ONS figures regarding DB membership indicate active membership of both open and closed private sector occupational DB schemes has fallen by approximately 3 million between 2000 and 2015. The rate of closures to accrual over that period has been steady, with employers being motivated by a desire to reduce both the cost of contributions and funding volatility. Inevitably, the number of active DB scheme members today will be even lower.

 By Vikki Massarano, ARC Pensions Law

 Further, the introduction of automatic enrolment obligations from 2012 onwards is likely to have been used by many employers as a spur to close their DB scheme to accrual, in order to harmonise benefits across the workplace.

 In general, on the closure of a scheme, benefits for active members at the point of closure are based on their service to and salary at that date. This benefit then increases in line with inflation. However, since the 1986 Courage case, schemes whose amendment power contains a restriction preventing a reduction in benefits which have been “secured” in the scheme have had to retain a salary link for the benefits of former active members. For many members, this can be a valuable additional benefit. In times when salary increases exceed the inflation measure used for revaluation of deferred benefits, or where members benefit from significant promotional increases, keeping the salary link increases benefits.

 Since the Courage case, many employers have sought to distinguish any restriction in their amendment power which did not use exactly the same words. From 1997, section 67 Pensions Act 1995 has prevented amendments which would affect “accrued rights”, without any reference to prospective benefits.

 Therefore, schemes whose amendment powers used the word “accrued” rather than “secured” were generally thought to be able to distinguish themselves from the position in the Courage case. It was believed that they could successfully break the salary link on closure. Many pension lawyers felt that the Courage decision turned on its facts and the background position. Consequently, were a court to consider the matter in the future, many in the pensions community thought it would be likely to be decided in a different way.

 Many advised clients accordingly about the need to maintain a salary link. Unfortunately, that view has so far been proved wrong.

 After the Gleeds decision in 2014 and the Sterling case of 2015, the distinction between “accrued” and “secured” in amendment power restrictions may no longer apply. Schemes which were thought to have closed without a salary link and been administered on that basis for many years, may find the link should have been maintained and that historic benefits may need to be revisited.

 In many cases this may lead to a potentially significant increase in scheme liabilities, not to mention the administrative difficulties involved. Not only would records need to be amended for members still in service but pensions in payment and transfers out would need to be revisited. As well as an actuarial impact on funding, there would be an immediate cost as pensions in payment would have been underpaid. Tax free cash would have been based on incorrect benefits. HMRC might need to be involved if payments of additional tax free cash are proposed. HR, payroll and scheme administrators will have a big exercise to turn back the clock and apply the salary link from the date of closure. Once the data has been recreated, revised actuarial calculations will be needed and funding discussions might be necessary.

 The judge in the Gleeds case decided there was no sensible rationale why “accrued” and “secured” should have different meanings, and it is hard to argue with that. It is difficult to imagine, before the Courage case, that one was chosen over the other in the drafting with the intention of a different outcome. The “normal” meaning of the words does not seem to lead to such a fundamental difference in outcome either. However, the outcome is that schemes with amendment power restrictions using either “accrued” or “secured” must continue to provide a salary link on closure, which is difficult to accept as the right outcome.

 The Courage case was decided in a very different pensions environment. The 1980s were a time of pension surpluses, limited employer funding obligations and far fewer member protections (including the need to provide revaluation on deferred benefits).

 Today, with so few remaining DB schemes open to accrual and a strict regulatory environment, as well as the financial environment in which employers have seen their contribution obligations steadily increase, it is difficult to make a case that either word should include a prospective entitlement to benefits based on future salary increases.

 The Sterling case may result in a Court of Appeal decision dealing with this point, and we may see the end of this interpretation. In the meantime, it is highly advisable that trustees and employers consider whether their scheme really is closed in the way they think it is!


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