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For most of the 20th century, pensions were an important and valuable part of the remuneration package for most UK public and private sector employees. Traditionally, those pensions were provided on a ‘final salary’ basis, which guaranteed employees a set proportion of their final salary in return for making a fixed contribution during their employment. The balance of the cost of benefits that could not be funded from those contributions would be provided by the employer, and pension assets were kept separate from the employer’s other assets in schemes written under trust.
Two events in the 1990s transformed the pensions landscape.
The first, revealed following the death of the media tycoon Robert Maxwell, was the misuse of £450 million of his businesses’ pension funds to keep his companies afloat: this was the catalyst for widespread reform of pensions law designed to strengthen the regulation of schemes and to protect members’ benefits.
The second, which began to occur at the end of the decade and continued into the new century, was the increase in the costs of final salary schemes, caused primarily by members living longer and a fall in long-term investment returns. This led to employers closing these schemes and replacing them going forward with ‘money purchase’ schemes, which provided members with whatever benefits that could be purchased by the assets they accumulated by their retirement. For many years, public sector schemes continued to provide final salary benefits, but these also became too expensive to fund, and were replaced in 2015 by less generous ‘career average’ benefits.
For pension lawyers, the effect of the Maxwell scandal was to shine a spotlight on the legal and economic vulnerability of pension benefits that had previously been taken for granted. Alongside greater legislative activity was a dramatic increase in litigation that has continued unabated to the present day: more than 90% of the reported pensions cases were decided after 1995.
What follows is a look at a couple of the many legal issues that affect the provision of pensions in the UK.
Some of the highest profile pensions cases have involved changes to schemes which mistakenly failed to comply with the requirements of the amendment powers in the schemes’ governing provisions. Among those that have caused the most trouble is the requirement for an amendment to comply with prescribed formalities (such as being made by a deed) and the prohibition on changes which prejudice already-accrued benefits.
The first of these has come into play due to the widespread belief that changes could be made informally, such as by member announcements, leaving the deed to be done later as a ‘tidying up’ exercise: after that practice was held in 2000 to be contrary to the formality requirements of the amendment power (Bestrustees plc v Stuart [2001] EWHC 549 (Ch)), a host of cases followed, emphasising how strictly that requirement would be enforced: the consequent invalidity of those amendments has cost pension schemes enormous sums in additional liabilities.
The prohibition on reductions to accrued benefits has caused particular problems with the closure to the future accrual of benefits in final salary schemes, where the calculation of the already-accrued benefits was changed to the members’ salary at the date of closure, rather than their salary at retirement: this ‘breaking of the final salary link’ has been held to amount to a reduction in member’s accrued benefits, so as to trigger the prohibition, and this too has proved extremely expensive for schemes.
One saving grace for schemes has been the tendency for courts to limit the ineffectiveness of amendments that fall foul of the prohibition on the reduction of accrued benefits, to that part of the change that operates retrospectively, thereby allowing the amendment to operate to reduce future benefits that were never intended to be protected by the prohibition. This is important, as the affected amendments were often made many years before the problem was discovered, and so would be much more expensive to correct if the amendment was found to be wholly invalid.
The court can only partially uphold the validity of amendments in this context where the prohibition is limited to protecting benefits which accrue prior to the change being made: fortunately, there are relatively few schemes with prohibitions that extend to benefits accrued after the date of the amendment. However, a recent High Court case (Virgin Media Ltd v NTL Pension Trustees II Ltd [2023] EWHC 1441 (Ch)) has held that a statutory provision that for many years prevented amendments being made to a particular type of scheme without certain prescribed actions being undertaken, operates to wholly invalidate the amendment, so that it is invalid as regards both past and future benefits. This decision has caused widespread alarm in the pensions industry: if correct, it is likely to result in huge increases in the costs of a large number of pension schemes; and the appeal, which was heard in June 2024, is one of the most important pensions cases to be decided for many years.
Pension schemes are subject to a non-discrimination rule imposed by the Equality Act 2010, and employers must be careful not to treat groups of employees differently where that amounts to unlawful discrimination. Two important examples of this issue are now considered.
First, the changes made to public sector schemes in 2015, which introduced new schemes with a benefit structure that was less generous for most members going forward, included transitional provisions for members who were near retirement age, which allowed them to remain in their more generous schemes for a further period. In 2018, the Court of Appeal held that younger members of two of the affected schemes, who did not qualify for the transitional protection, had been discriminated against on the grounds of age (Lord Chancellor v McCloud; Secretary of State for the Home Department v Sargeant [2018] EWCA Civ 2844). This decision, which the government has accepted applies to all public sector pension schemes, has led to legislation removing the discriminatory provisions and providing for a system of compensation for affected members. Getting to this position has been a long and tortuous process and will likely cause an estimated £19 billion increase in the cost of public sector pensions.
Another important discrimination issue concerns the types of pension investment funds made available to Muslim employees. Muslims are required to ensure that their money is invested in a way that does not contravene the Sharia rules relating to finances, most notably the prohibition on the accrual of interest. While there are a number of Sharia-compliant pension investment funds, many schemes do not offer such funds to their members, which may compel Muslim employees not to join or to opt out of the scheme. In that situation, the employer may face a claim for unlawful discrimination on the basis of religion. This issue is likely to be of particular relevance to money purchase schemes, where members are usually given a choice as to how their assets are invested; the position for final salary schemes is more complex, as members have no say on the investment of the funds, and the scheme trustees, in whom investment duties are vested, cannot usually take account of non-financial considerations. As yet there have been no discrimination claims on this basis, but it is likely to be only a matter of time before they are brought.
For most of the 20th century, pensions were an important and valuable part of the remuneration package for most UK public and private sector employees. Traditionally, those pensions were provided on a ‘final salary’ basis, which guaranteed employees a set proportion of their final salary in return for making a fixed contribution during their employment. The balance of the cost of benefits that could not be funded from those contributions would be provided by the employer, and pension assets were kept separate from the employer’s other assets in schemes written under trust.
Two events in the 1990s transformed the pensions landscape.
The first, revealed following the death of the media tycoon Robert Maxwell, was the misuse of £450 million of his businesses’ pension funds to keep his companies afloat: this was the catalyst for widespread reform of pensions law designed to strengthen the regulation of schemes and to protect members’ benefits.
The second, which began to occur at the end of the decade and continued into the new century, was the increase in the costs of final salary schemes, caused primarily by members living longer and a fall in long-term investment returns. This led to employers closing these schemes and replacing them going forward with ‘money purchase’ schemes, which provided members with whatever benefits that could be purchased by the assets they accumulated by their retirement. For many years, public sector schemes continued to provide final salary benefits, but these also became too expensive to fund, and were replaced in 2015 by less generous ‘career average’ benefits.
For pension lawyers, the effect of the Maxwell scandal was to shine a spotlight on the legal and economic vulnerability of pension benefits that had previously been taken for granted. Alongside greater legislative activity was a dramatic increase in litigation that has continued unabated to the present day: more than 90% of the reported pensions cases were decided after 1995.
What follows is a look at a couple of the many legal issues that affect the provision of pensions in the UK.
Some of the highest profile pensions cases have involved changes to schemes which mistakenly failed to comply with the requirements of the amendment powers in the schemes’ governing provisions. Among those that have caused the most trouble is the requirement for an amendment to comply with prescribed formalities (such as being made by a deed) and the prohibition on changes which prejudice already-accrued benefits.
The first of these has come into play due to the widespread belief that changes could be made informally, such as by member announcements, leaving the deed to be done later as a ‘tidying up’ exercise: after that practice was held in 2000 to be contrary to the formality requirements of the amendment power (Bestrustees plc v Stuart [2001] EWHC 549 (Ch)), a host of cases followed, emphasising how strictly that requirement would be enforced: the consequent invalidity of those amendments has cost pension schemes enormous sums in additional liabilities.
The prohibition on reductions to accrued benefits has caused particular problems with the closure to the future accrual of benefits in final salary schemes, where the calculation of the already-accrued benefits was changed to the members’ salary at the date of closure, rather than their salary at retirement: this ‘breaking of the final salary link’ has been held to amount to a reduction in member’s accrued benefits, so as to trigger the prohibition, and this too has proved extremely expensive for schemes.
One saving grace for schemes has been the tendency for courts to limit the ineffectiveness of amendments that fall foul of the prohibition on the reduction of accrued benefits, to that part of the change that operates retrospectively, thereby allowing the amendment to operate to reduce future benefits that were never intended to be protected by the prohibition. This is important, as the affected amendments were often made many years before the problem was discovered, and so would be much more expensive to correct if the amendment was found to be wholly invalid.
The court can only partially uphold the validity of amendments in this context where the prohibition is limited to protecting benefits which accrue prior to the change being made: fortunately, there are relatively few schemes with prohibitions that extend to benefits accrued after the date of the amendment. However, a recent High Court case (Virgin Media Ltd v NTL Pension Trustees II Ltd [2023] EWHC 1441 (Ch)) has held that a statutory provision that for many years prevented amendments being made to a particular type of scheme without certain prescribed actions being undertaken, operates to wholly invalidate the amendment, so that it is invalid as regards both past and future benefits. This decision has caused widespread alarm in the pensions industry: if correct, it is likely to result in huge increases in the costs of a large number of pension schemes; and the appeal, which was heard in June 2024, is one of the most important pensions cases to be decided for many years.
Pension schemes are subject to a non-discrimination rule imposed by the Equality Act 2010, and employers must be careful not to treat groups of employees differently where that amounts to unlawful discrimination. Two important examples of this issue are now considered.
First, the changes made to public sector schemes in 2015, which introduced new schemes with a benefit structure that was less generous for most members going forward, included transitional provisions for members who were near retirement age, which allowed them to remain in their more generous schemes for a further period. In 2018, the Court of Appeal held that younger members of two of the affected schemes, who did not qualify for the transitional protection, had been discriminated against on the grounds of age (Lord Chancellor v McCloud; Secretary of State for the Home Department v Sargeant [2018] EWCA Civ 2844). This decision, which the government has accepted applies to all public sector pension schemes, has led to legislation removing the discriminatory provisions and providing for a system of compensation for affected members. Getting to this position has been a long and tortuous process and will likely cause an estimated £19 billion increase in the cost of public sector pensions.
Another important discrimination issue concerns the types of pension investment funds made available to Muslim employees. Muslims are required to ensure that their money is invested in a way that does not contravene the Sharia rules relating to finances, most notably the prohibition on the accrual of interest. While there are a number of Sharia-compliant pension investment funds, many schemes do not offer such funds to their members, which may compel Muslim employees not to join or to opt out of the scheme. In that situation, the employer may face a claim for unlawful discrimination on the basis of religion. This issue is likely to be of particular relevance to money purchase schemes, where members are usually given a choice as to how their assets are invested; the position for final salary schemes is more complex, as members have no say on the investment of the funds, and the scheme trustees, in whom investment duties are vested, cannot usually take account of non-financial considerations. As yet there have been no discrimination claims on this basis, but it is likely to be only a matter of time before they are brought.
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