UK: Pensions Briefing Note - Issue 3

Pensions Reform

Removal of the Default Retirement Age ("DRA")

Up until 6 April 2011, employers could require staff to retire at age 65. However, the DRA of 65 was removed from legislation from 6 April 2011, meaning that employers now need to objectively justify having a compulsory retirement age. There is a short transitional period to allow retirements to go ahead where employees reach age 65 before 1 October 2011.

Due to concerns raised during consultation, the Government has agreed that an exception will be made for group risk insured benefits (such as life assurance), so these can still be stopped at age 65 (rising in line with state pension age). The exception will not cover benefits provided on a self insured basis.

The Government has said that "the removal of the DRA does not affect occupational pension schemes" as schemes will be permitted to retain a normal retirement age ("NRA"). However, that does not address what provision should be made for employees working beyond the scheme's NRA.

Action

Employers still applying a DRA should consider (and document) how they will objectively justify it if an employee makes an age discrimination claim against them.

Employers and trustees will also need to consider the benefits they provide to those working beyond NRA; offering no, or lower value, benefits is likely to be age discrimination unless it can be objectively justified. Increased cost on its own is unlikely to be sufficient to objectively justify otherwise discriminatory practices.

Removal of the DRA may also lead to an increase in the popularity of flexible retirement (employees drawing part or all of their benefits but continuing to work). Trustees and employers should remember that it is not just older employees who can bring age discrimination claims; younger employees can bring a claim too.

Regulatory

Who is the employer?

Good administration, record keeping and regular monitoring of the employer covenant have long been key areas of focus for the Pensions Regulator. One of the areas where these issues come together, is knowing which employers are liable to fund the benefits provided under a scheme. This mainly affects defined benefit schemes. Where there have been corporate reorganisations this can be particularly difficult. But trustees have a duty to ensure that they know who is liable to fund the benefits under the scheme, that they monitor the covenant of all of those employers and that they call in any debt that may be due to the scheme in order to better protect members' benefits.

It is also important for companies to be aware that they may still be liable to fund benefits under a defined benefit scheme even where they no longer employ active members of that scheme (and may not have done so for a long time.

Action

Trustees need to ensure that they understand which liabilities under the scheme are attributable to which employers and how those liabilities would be met if an employer departed the scheme, became insolvent, or the scheme were to wind up. This means trustees should know: (a) which companies in the employer group actually employ the active members of their scheme; and (b) which companies have previously employed active members of the scheme and have ceased to do so but may still owe a debt (actual or contingent) to the scheme. This latter scenario can arise where schemes are frozen or where a statutory debt has been triggered but not yet called in by the trustees. The starting point for trustees will be to liaise with their advisers and the employer's HR department to ensure they have all of the necessary information and that it is included in the scheme records for future reference.

Cases

Association belge des Consommateurs Test- Achats ASBL - no more sex-based actuarial factors?

The European Court of Justice ("ECJ") has handed down its decision in the Test-Achats case, in which a consumer group challenged the validity of an exemption in a European Directive that permits insurers to use sex as a determining factor in their assessment of risk, where it is based on "relevant and accurate actuarial and statistical data". Key points from the decision are:

• It will impact upon the purchase of certain annuities by pension scheme trustees and members.
• The impact on occupational pension schemes is uncertain. Currently, schemes are allowed to use sex-based actuarial factors to determine things like funding requirements, transfer values and commutation. The Government will have to decide whether that legislation should be amended in light of the ECJ's decision.

• What seems certain is that, from 21 December 2012, insurers will need to use sex neutral factors for assessing premiums and benefits under new insurance contracts, including annuities. But the extent (if any) to which annuities already in place before that date will be affected remains to be seen.

Action

Trustees do not need to take action immediately, but they should monitor the fallout from the case with their advisers. When they are considering actuarial factors, trustees should bear in mind the direction in which Europe appears to be moving when it comes to the use of sex-based factors.

Prudential Staff Pensions Limited v The Prudential Assurance Company Limited and others - discretionary pension increases

This case was brought by the trustee (at the request of the members) who challenged the right of the employer to change the basis on which discretionary increases to pensions in payment were granted.

The High Court confirmed that exercising a discretion in a consistent way for a long period (in this case, over 50 years) does not turn the discretion into a guarantee. It takes more than just member expectations that the practice will continue to convert a discretionary practice into a binding obligation.

The judge said that:

• The test for a breach of the obligation of good faith was whether Prudential had acted irrationally or perversely in changing its practice of granting increases in line with RPI.
• In this case, Prudential's decision to limit discretionary increases to RPI capped at 2.5% was not irrational or perverse.
• The duty of good faith is not the same as a duty to act reasonably or reach a "fair" decision.
• An employer's power to grant pension increases is not fiduciary and isn't subject to the usual tests of taking into account all relevant factors and no irrelevant factors. The employer can have regard to its own interests (despite the members' strong and reasonable expectations that the practice of granting increases in line with RPI would continue).

Comment

This case is clearly relevant to schemes with an established practice of regularly awarding discretionary pension increases, particularly where the continuation of such a practice is being reviewed. It provides comfort to employers that a "discretion" to increase benefits is just that, and that past practice alone cannot create an entitlement. But the case does show the tension between the significant potential cost savings to employers, and the emotive nature of the issue for the pensioners involved.

The judge's analysis of employers' duties of good faith to scheme members is also relevant more widely to the role of the employer in relation to pension schemes. In particular, employers looking to reduce their exposure to defined benefit liabilities will need to manage any such liability reduction exercise carefully.

As things stand, for an employer to breach the obligation of good faith, it is necessary for their decision to be irrational or perverse; a very high hurdle.

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.