UK: Pensions Update - Spring 2003

The combination of tumbling stock markets, the advent of the new accounting standard FRS17, and the loss of advance corporation tax relief on pension fund investments (the "£5 billion stealth tax") has driven many employers to look hard at the cost of final salary pension schemes, and ask whether they are still affordable.

The three most common responses have been winding up the scheme; closing it to new members (but allowing existing members to continue); and introducing (or increasing) a requirement for the members to pay contributions.

In this article we will look at the third of these options.

Increasing the members’ contributions does not, of course, address the fundamental problem of final salary schemes, which is the open-ended and unquantifiable nature of the employer’s commitment. If the desire is to fix, or cap, the employer’s cost exposure, then ultimately the only way to achieve that is by pulling out of final salary provision and switching to money purchase.

But many employers have preferred to uphold their commitment to final salary pensions, while asking their staff to recognise, and share, the increasing cost.

To drive such a change through successfully, there are a number of legal hurdles that have to be negotiated.

First, do the rules of the pension scheme allow it? The power of amendment contained in the trust deed, and any restrictions on that power, should be considered very carefully. It may also be necessary to consider the effect of the Pensions Act 1995, which effectively prohibits any scheme amendment that impacts adversely on the members’ accrued rights.

Then, the amendment power may be subject to the consent of the scheme trustees. What will their attitude be?

If the necessary powers exist to change the scheme rules, the next problem is whether it can be done without breaching contracts of employment. Many contracts or engagement letters say very little about an employee’s pension rights. Often they will just say that he is entitled to join the scheme, and that further details are available on request, or are contained in a member’s handbook. At the other extreme, some contracts (usually for senior executives) may set out specific pension entitlements in some detail.

If the contract refers to a separate booklet for details of the pension scheme, then the contents of the booklet may be deemed to be incorporated in the contract. And if the booklet contains a statement that the employer has the power to alter the scheme, that may mean that the necessary changes can be made without any breach of contract. But every case will be different, and will depend on the precise wording of the contract and the surrounding documents.

If it is concluded that introducing contributions unilaterally would be a breach of contract, then the only alternative may be to consider changing the terms of employment by consent. The question is then, what to do about any employees who refuse.

The new terms can be imposed, running the risk of a "reservation of rights" by disaffected employees; or in the worst case, constructive dismissal claims.

The ultimate sanction, if one is looking for certainty, is to terminate their contracts by notice, and offer them immediate re-engagement on the new terms. That would, in principle, give them the option of claiming that the dismissal was unfair, and seeking compensation from the Employment Tribunal. But in order to do that, they would in fact have to refuse the offer of re-engagement. In most cases, only the most hostile employees would be prepared to go that far.

If the trust law and contractual problems can all be overcome, there is another trap which is easily forgotten, namely the statutory obligation to get employees’ written consent before deducting contributions from their pay. At first glance, this seems like another opportunity for employees to block the change; but if the legal analysis is that contributions can be introduced without breaching contracts, then an employee who refuses to give consent for those deductions can probably be treated as opting out of the pension scheme.

Apart from simply imposing, or increasing, member contributions there are various more subtle variations. For example a scheme could be split into two sections, with one section preserving the existing benefit scales and imposing increased contributions, while the other section allows members to continue on the old contribution rate, but with a reduced rate of benefit accrual for future service.

Another approach which some employers have taken is to convert the scheme to a "shared cost" basis, in which the members’ contributions and the employer’s contribution are in a fixed ratio. This raises more complicated issues of scheme design, but its perceived merit lies in bringing home to members the true cost of the scheme, and the fact that costs can be volatile.

Newham London Borough Council -v- Skingle (Court of Appeal)
In our July 2002 issue we reported the decision of the High Court, when it overturned the Pensions Ombudsman’s determination that "contractual overtime", for the purposes of the Local Government Pension Scheme, included all overtime for which the employee’s contract prescribed a rate of pay; even if the contract did not actually oblige him to work any overtime. The High Court rejected this argument, finding that "contractual" overtime was in effect equivalent to "compulsory" overtime.

The Court of Appeal has now reversed the High Court’s decision; but on the grounds that Mr Skingle’s contract had, in fact, obliged him to work the overtime in question. So although Mr Skingle won his appeal, the underlying law remains the same: that is, for calculating benefits under the LGPS (and other schemes with similar rules) overtime will only be included if the member is contractually required to work it.

Watts -v- Barking and Dagenham London Borough Council (High Court)
Another appeal against a decision of the Pensions Ombudsman, in a Local Government Pension Scheme case. The authority had, for a number of years, paid Miss Watts a "long service award", as an enhancement to her pension. The authority then received legal advice that the enhancement payment was, or might be, beyond its legal powers; and it withdrew the payment.

The Ombudsman decided this amounted to maladministration, and ordered the payment to be reinstated. The High Court ruled that the Ombudsman had been wrong on the maladministration point: the authority had acted with thoroughness and care in reaching its decision, and acting on a mistaken view of the law did not amount to maladministration. However the Court upheld Miss Watts’s right to the long service award, for other reasons.

Davies (Pensions Ombudsman)
Mrs Davies alleged maladministration by her employer, in failing to provide her with information on the ability of part-time employees to claim backdated service, for pension purposes. The Ombudsman found that the employer was not under a duty to provide Mrs Davies with the information in question; and that in fact, its knowledge on these matters at relevant times was no more than the information that was in the public domain, and was already known to Mrs Davies. Therefore the employer was not guilty of maladministration.

Matthews (Pensions Ombudsman)
Mr Matthews was a member of the Teachers’ Pension Scheme. He continued working after his normal pension age of 60, on a part-time basis. He elected to have this service treated as pensionable, and contributions were deducted from his pay.

When he eventually retired, the scheme administrators found that under the TPS rules he should not have been allowed to treat the part-time service as pensionable. They refunded his contributions, and offered compensation of £1000.

The Ombudsman found that the administrators were clearly guilty of maladministration, and that the compensation offered did not adequately redress the injustice. He said that if Mr Matthews had been told the true position, he would probably have switched from part-time to full-time service; and would have planned for his retirement differently.

The Ombudsman ordered the administrators to pay compensation equivalent to the extra benefits Mr Matthews would have received from the TPS, if his part-time service had in fact been pensionable.

Pensions Green Paper
As reported in our last issue, the long awaited Pensions Green Paper was published in December 2002. The consultation period ended on 28 March (for the DWP part of the paper) and on 11 April (for the Treasury/Inland Revenue part). The Government will now take time to consider the responses before, it is thought, publishing a Pensions Bill in the autumn.

Pensions Ombudsman’s jurisdiction
The office of Pensions Ombudsman was created by the Social Security Act 1990. The policy intention, as explained by the then Secretary of State in 1989, was that he should deal with the types of problem facing individuals, rather than schemes. In a number of high profile cases, the courts have tried to define the limits of the Ombudsman’s jurisdiction. In particular, they have ruled that he cannot make orders which would impact on persons who are not a party to the particular complaint he is considering. In other words, his decision regarding one scheme member cannot bind the membership generally, and he cannot deal with "class actions". In the Child Support, Pensions and Social Security Act 2000 the Government was persuaded by the then Ombudsman to introduce powers for him to deal with class actions. However, those powers have not been brought into force, and in March 2003 the Government announced that it will not do so. The reason given was that current pensions policy is all about "simplification"; and giving the Ombudsman power to deal with class actions would instead make the law more complex. The Government says it will consider the position further in the light of the responses to the Green Paper.

New OPRA Guides
The Occupational Pensions Regulatory Authority has launched a new range of leaflets for the benefit of pension scheme trustees, covering such topics as "How to keep members informed", "How to appoint professional advisers" and "How to appoint a scheme actuary". These are described as "at a glance" guides which are intended to refer trustees to OPRA’s more detailed guidance and publications.

The Myners Review
In March the Government commenced its (previously announced) review of the extent to which pension schemes are complying with the "principles for institutional decision making" set out in the Myners Review of Institutional Investment, published in March 2001. The Government "expects" that pension schemes will voluntarily (and publicly) disclose their compliance with the principles; but has threatened to legislate if its expectation is disappointed.