UK: Merchant Navy Judgment: Good News For Frozen Schemes

The High Court gave judgment this week in the eagerly awaited Merchant Navy Ratings case. The judgment covers two main areas of general interest to defined benefit pension schemes:

  • the extent to which the trustee could properly take account of the interests of employers when amending the scheme to adopt new deficit repair contribution arrangements; and
  • whether the existence of "enhanced" deferred members prevented the scheme from being a frozen scheme.

Background to the case

The scheme is an industry-wide non-segregated occupational pension scheme with a sole corporate trustee. It has approximately 30,000 members and the preliminary 2014 valuation showed a deficit on an ongoing basis of Ł325m (70 per cent funded).

Earlier litigation in 2001 had resulted in liability for deficit repair contributions being imposed on 40 "Current Employers" (employing active members of those eligible to join the scheme). Under that regime the other "Historic Employers" (of which there are 200) had no obligation to contribute. This meant that the Current Employer were bearing 100 per cent responsibility for the deficit even though only about 30 per cent of the liabilities were attributable to employment with them.

The scheme was closed to future accrual on 31 May 2001. Some members were given enhanced revaluation rights on their deferred benefits.

The Trustee wanted to amend the scheme and adopt new deficit repair arrangements which would include Historic Employers in the pool of those who must contribute and to give credit to Current Employers for contributions made since 2001 (the New Regime). The Trustee considered that:

  • its fundamental objective was to eradicate the deficit in a way it considered appropriate;
  • it should exercise its powers for the purpose for which they were conferred i.e. providing benefits for members; and
  • subject to the above it could introduce the new arrangements and take appropriate action to address the past cross-subsidy.

Proper purpose issue

The trustee could only exercise the power of amendment in order to further the purposes of the scheme. There was detailed argument on the extent to which this could properly include taking into account the interests of the employers (particularly the Current Employers who would see a reduction in their liabilities if the New Regime were to be adopted).

The court considered what the duty to "act in the best interests of the beneficiaries" means and the extent to which it may include consideration of the position of employers. The court held that as long as the primary purposes of securing benefits is furthered, it is reasonable and proper, should the trustee consider it appropriate to do so, to take into account employers' interests both when determining to widen the pool of contributing employers and when considering giving credit for contributions already made.

There is nothing improper when furthering the purposes of the scheme, if some employers may ultimately pay less. The possibility of a reduction in liability for any employer is, at best, a side effect of the purpose for which the power is exercised.

Frozen scheme issue

The parties wanted the court to confirm whether the scheme became a "frozen scheme" on 31 May 2001 when accrual had ceased. The uncertainty was caused by a group of "Specified Members" who are entitled to enhanced revaluation on their deferred benefits. The significance of this question lies in the Employer Debt Regulations – if the scheme is not "frozen" a Current Employer may trigger a section 75 debt when it ceases to employ a Specified Member. This may appear to be a narrow technical issue but is in fact important for many schemes. If the court had held that it was not a "frozen scheme" it would have meant that many DB schemes which had thought they were frozen in fact still have active members and so employer debts could be triggered inadvertently.

The court undertook a detailed analysis of the relevant legislation and concluded that if enhanced revaluation is provided then this does not prevent it being a "frozen scheme".

The ruling could also impact on schemes which have retained final salary linkage (or a final salary linkage underpin) on closure to future accrual. Many such schemes have, because of uncertainties as to the law, taken a cautious view and treated the scheme as still having active members. This judgment, although not directly a decision on final salary linkage, should give them some comfort that debts are not triggered when an employer loses its last final salary linked member.

The judgment will therefore come as a relief to many schemes and pensions practitioners.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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