18th October 2018 Uncertainty over PPF Compensation
On 6 September 2018, the Court of Justice of the European Union (CJEU) provided its ruling in Hampshire v The Board of the Pension Protection Fund (PPF). The judgment has important implications for the calculation of PPF compensation, with existing arrangements found to be in breach of EU law. It is not yet clear how the Government will respond.
Under EU law, the UK is required to implement “necessary measures” to protect members’ accrued rights to pension benefits under occupational pension schemes in the event of employer insolvency.
Protection is provided by the PPF which pays “compensation” subject to certain conditions and restrictions. Broadly, members who have reached their scheme’s normal retirement age at the assessment date receive compensation equivalent to 100% of their scheme pension; members under normal retirement age receive 90%, subject to a cap (which broadly equates to a maximum pension of £35,000 per year at age 65). The cap can result in some members receiving less than 50% of their full pension entitlement.
Once in payment, compensation generally increases at a lower rate (if increases are payable at all), which can lead to a further erosion of benefits over time, compared to the benefits the member would otherwise have received under the scheme.
Mr Hampshire was a member of the Turner & Newall plc pension scheme between 1971 and 1998. He retired early and was under normal retirement age when the scheme entered a PPF assessment period in 2006.
Had the scheme entered the PPF Mr Hampshire would have been caught by the cap on compensation, resulting in a reduction of approximately 67%. Mr Hampshire brought a legal challenge on the basis that the amount of the reduction was inconsistent with EU law. The Court of Appeal subsequently referred the matter to the CJEU for directions.
The CJEU agreed with Mr Hampshire. Under EU law, individual members are entitled to compensation equivalent to at least 50% of the value of their accrued entitlement in the event of employer insolvency (which therefore operates as an underpin to the PPF compensation cap). Furthermore, the value must be determined taking into account the envisaged growth in the pension over time.
Whilst the case will be remitted back to the Court of Appeal, the Court is expected to follow the CJEU’s lead.
The PPF is working with the Department for Work and Pensions (DWP) to consider the judgment but has said the “vast majority” of members already receive 50% of their accrued benefits, so the number of affected members is likely to be very small (in July 2017 the PPF estimated that around 0.5% of members were caught by the cap).
However, we expect the PPF rules (set out in legislation) will have to change and it seems compensation will have to be backdated where applicable. In advance of new legislation, the PPF is putting in place an interim process to uplift payments now and will be writing to affected members in tranches in the coming weeks.
In theory, PPF levies may rise, but given the PPF’s robust funding position, it would seem a material rise is unlikely for most schemes, unless PPF compensation is changed in a significant way. Levies may increase for schemes whose members are currently unlikely to receive more that 50% of their accrued entitlement.
It is unclear how the DWP will respond to the judgment and whether this will prompt a larger review of PPF compensation. The current compensation cap is the obvious problem, but the CJEU’s comments about taking into account future increases, also creates uncertainty as to whether this requires an ongoing review or whether it is appropriate to make assumptions at the outset, which then raises questions as to how that translates into an equivalent amount of compensation (the PPF seems to anticipate a one-off change to the headline level of compensation at the PPF assessment date with existing PPF indexation and revaluation rules used thereafter).
What do schemes need to do?
The ruling is unlikely to have any immediate impact on the majority of schemes, although trustees may wish to ascertain whether any of their members would be affected should the scheme enter the PPF.
For schemes not in winding up or in assessment period, the judgment could still be relevant. Where a scheme is reducing transfer values and the reduction is linked to the statutory winding up priority order, where PPF compensation limits are an important factor, the trustees may need to reassess the reduction. Also, if part of the scheme’s covenant is provided by a guarantee linked to the scheme’s PPF funding level, the trustees may need to reconsider whether the change impacts on the guarantor’s ability to pay.
The case will also be of interest to those schemes currently in a PPF assessment period or winding up who may be reducing benefits in line with PPF compensation rules, where there may be a clear conflict between existing legislation and the CJEU’s judgment. Affected schemes will want to take legal advice to consider what action can/should be taken prior to legislative change.
There are also potential complications for schemes that have already wound up outside of the PPF, where benefits may have been secured at less than 50% (but on the understanding that the benefits were in line with (or better than) the equivalent PPF compensation). Uncertainty remains as to how such members might be compensated.
Schemes may wish to wait for further clarity before taking any definitive action.
Senior Associate Robert Walker
Please read Robert’s article in Actuarial Post
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. ARC Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.