Two recent High Court decisions have cast doubt over the effectiveness of many years’ worth of cost-saving changes to defined benefit (“DB”) pension schemes designed to reduce members’ future service benefits.  Some schemes will potentially move from surplus into deficit as a result and sponsoring employers could in turn find themselves facing substantially increased liabilities.  Transactions involving DB schemes now face an added layer of validity risk and pricing uncertainty.

Procedural defect can make rule amendments invalid

The judgment in Virgin Media v NTL Pension Trustees has called into question certain rule amendments for contracted out DB pension schemes made between 1997 and 2016.  The Court held that rule amendments in relation to rights under those schemes (known as “section 9(2B) rights”) made without an actuarial confirmation under section 37 of the Pension Schemes Act 1993 were void.  The requirement to obtain such a confirmation applied (said the Court) to amendments relating to benefits for both the past and the future, and whether they were detrimental to members or not.

For affected schemes this means that, if there was no section 37 confirmation in relation to a particular amendment, there is a particular risk of changes to members’ future service benefits made during the 2000s and 2010s being invalid.  It might be the case that members have actually (yet unwittingly) been earning benefits on the original, more generous basis for a good many years.  Clearly this could have a knock-on impact on the scheme’s funding position and the liabilities that its sponsoring employer has towards the scheme.

We understand it is expected that there will be an appeal, although definitive timings are not known at present.  There is also speculation within the industry that the DWP will legislate to address the issues to which the judgment gives rise, although we are similarly unable to comment on the likelihood of this.  Until there is more certainty as to how the issue might be resolved, corporate groups with DB pension schemes should prepare themselves for legal uncertainty relating to the status of any changes to their rules.  A knock-on impact on transactions, particularly in relation to pricing, can also be expected.

Members “interests” include their expectation of earning pensions in the future

Another recent decision of the High Court also has the ability to cast doubt on the validity of some schemes’ historical rule amendments (and the ability to prevent benefit changes in the future by other schemes).  It shows how archaic or nebulous language in old pension scheme deeds can hamper employers from adopting modern-day remuneration strategies for their workforce.

BBC v Christina Burns concerned the BBC’s desire to reduce the ‘future service’ benefits to be earned by members of its (said to be cripplingly-expensive) DB pension scheme.  The scheme’s amendment power prevented alterations that prejudiced the “interests” of members of the scheme.  It wasn’t clear whether this restriction simply applied to benefits that members had already earned, or whether it also prevented forward-looking changes to the level of benefits they had not yet earned.  The Court was asked by the BBC to interpret the scheme’s rules.

The Court said that “interests” included not only pensions already earned, but also the pensions that members of the scheme would earn in the future if they remained employed by the BBC.  Any detrimental change to those ‘future service’ benefits was therefore prohibited by the scheme’s own rules.  The BBC had not proposed any particular level of cuts to members’ future pensions, but the Court made it clear that any reduction in future benefits would be outlawed by the restriction in the rules.

It is possible that schemes with a similar restriction (or ‘fetter’) in their amendment power have, in the past, made changes to the level of benefits that their members earn.  They may even have closed to future accrual entirely, perhaps on the back of legal advice that “interests” could only properly refer to benefits that members had already earned.  The sponsoring employer of any scheme in such a position may wish to consider whether there is any risk of the change not having been validly made.

Similarly, employers planning to make ‘future service’ changes should always consider the terms of their scheme’s amendment power very carefully.  Older schemes in particular may contain language that does not really have a clear modern-day meaning.  Along with other words such as “secured” and “accrued”, a restriction on prejudicing “interests” should now be a red flag that the proposed changes to members’ benefits may not in fact be lawfully possible.

We understand that the BBC is likely to appeal the ruling so it would be premature to reach any firm conclusions on the basis of the High Court’s judgment.  Remember too that restrictions in scheme rules differ – sometimes in a nuanced fashion, sometimes much more markedly – and any scheme has to be construed on its own precise wording.

Key takeaway

Groups of companies with defined benefit pension schemes face an uncertain time while these issues are resolved, and corporate activity involving sponsoring employers is likely to bring them into sharp focus.  A pragmatic, risk-focused approach to assessing questions of validity can often help with navigating the weeds and finding a proportionate way through to safer shores.