Many readers will know the uncertainty and impact of certain landmark decisions such as Barber v Guardian Royal Exchange and Lloyds Banking Group Trustees v Lloyds Bank on UK pension schemes. Last month, the High Court handed down Virgin Media Limited v NTL Pension Trustees II Limited which could have similar wide-reaching consequences for UK pension schemes which were historically contracted out on a salary-related basis. Below, we summarise the judgment, and consider the impact on UK pension schemes and what (if anything) trustees should be doing.
The judge in the Virgin Media case found that amendments made to the scheme were void because the actuary had not provided the Section 37 Confirmation (often provided in a certificate and hence known as a Section 37 certificate) and therefore benefits had been paid out (and funded) on an incorrect basis.
If you made amendments to your pension scheme between April 1997 and April 2016 and your scheme was contracted out on a salary-related basis, the legislation requires you to have obtained Section 37 Confirmation. We come across historical documents of many schemes where this confirmation is "missing" and until the Virgin Media case the effect of this omission was unclear.
The Virgin Media case is likely to be appealed (we should know in the short term) but if it is not appealed (or the appeal is unsuccessful) trustees will need to consider whether they made amendments to their scheme between April 1997 and April 2016 and if so whether there is Section 37 Confirmation for each amendment. If the required Section 37 Confirmation is not evident, trustees should consider obtaining legal advice on the validity of the proposed amendments and the impact on the benefits already paid, future benefits and how this affects the funding basis.
However, unless your scheme is on the cusp of buy-out we would suggest it is appropriate for trustees to wait until the final outcome of the Virgin Media case is determined.
Re-cap on contracting-out
Prior to April 2016, occupational pension schemes could contract out of the state second pension on a salary-related basis (it was also possible to contract out on a money purchase basis until 2012, but that is not relevant to the Virgin Media case). Where a scheme was contracted out, members and the scheme employer benefited from a lower rate of National Insurance contributions, and in return the scheme provided certain benefits for members in place of the state second pension.
Until 1997, the benefit provided by an occupational pension scheme in place of the state second pension was the separately identifiable guaranteed minimum pension, or GMP (if your scheme has GMP, you are probably grappling with the GMP equalisation requirement as a result of the Lloyds Bank decision noted above). From April 1997 onwards (until the abolition of contracting-out), the benefit ceased to be separately identifiable and instead the pension scheme as a whole had to meet a minimum standard known as the "reference scheme test".
The reference scheme test required schemes to provide benefits that were "broadly equivalent to, or better than" the benefits provided by a notional reference scheme. Members' rights to benefits meeting the test have the catchy label of "section 9(2B) rights", (we need more creativity in the pensions world!) after the relevant provision of the Pension Schemes Act 1993. Schemes which met the test held a contracting-out certificate, and every three years the scheme actuary was required to certify that the reference scheme test continued to be met.
Amendments to contracted-out schemes
Any amendments to a contracted-out scheme after April 1997 could have had an impact on whether the scheme continued to meet the reference scheme test and therefore legislation set out a process to be followed – specifically section 37 of the Pension Schemes Act 1993 (section 37) and regulation 42 of the Occupational Pension Schemes (Contracting-out) Regulations 1996 (regulation 42).
In relation to amendments affecting section 9(2B) rights, these legislative provisions required trustees to obtain written confirmation from the scheme actuary that the scheme would continue to meet the reference test following the amendment. This confirmation was generally provided in the form of a certificate and is generally known as a "section 37 certificate" but is referred to in regulation 42 as a "Section 37 Confirmation".
For many years there has been uncertainty as to what impact a failure to obtain a Section 37 Confirmation has on a rule amendment. Although we are aware of this issue affecting many schemes (not unlike the question of whether GMP had to be equalised) the Virgin Media case is the first time that the question has been decided in a court.
The pension scheme in Virgin Media had been amended in 1999 and no Section 37 Confirmation could be found. The purpose of the amendment was for pension built up after the amendment date to have a lower rate of revaluation than pension built up before the amendment date (if the member commenced their pension from deferred status).
The High Court was asked to determine three issues:
- Does section 37 mean that the amendment is void because the trustees did not obtain a Section 37 Confirmation?
- Do the amendment formalities required by section 37 apply only in relation to amendments to pension already built up, or do they also need to be complied with in relation to amendments to pension that will build in the future?
- Does section 37 only apply to amendments which have an adverse effect on section 9(2B) rights, or does it apply to all amendments relating to section 9(2B) rights?
Issue one – is an amendment void without a Section 37 Confirmation?
The judge applied a literal interpretation to the wording of section 37(1), which states that the rules of a contracted-out scheme "cannot be altered" unless the requirements of regulation 42 are complied with. Her conclusion was that the legislation is clear: it is not possible to validly amend a contracted-out scheme without first obtaining a Section 37 Confirmation, and any amendment which did not comply with that requirement is void.
Issue two – does section 37 apply only to amendments to past pension, or to future pension too?
The lawyers for the employer put forward a number of arguments which all failed to persuade the judge and she determined that the requirements applied to proposed amendments to both past and future pension savings.
Issue three – does section 37 apply only to adverse amendments, or to all amendments?
Again, the lawyers for the employer failed to persuade the judge of their view and she concluded that there was nothing in the wording of the legislation which suggested Section 37 Confirmation was only required in relation to adverse amendments – the reference is simply to alterations relating to "any section 9(2B) rights". As such, her decision was that the requirement for a Section 37 Confirmation relates to all amendments whether or not they have an adverse effect.
What does this mean in practice for pension schemes which were previously contracted out?
The principal employer's arguments for a pragmatic approach to a failure to obtain a Section 37 Confirmation failed on all counts: if this judgment is not successfully appealed, all amendments to a contracted-out scheme are likely to be automatically void if a Section 37 Confirmation was not obtained meaning many pension schemes will have paid out (and are still paying out) incorrect benefits. In a similar vein to the adjustments trustees made to benefits following the Barber and Lloyds decisions, Virgin Media will require benefit and funding adjustments.
What if there is no appeal / or any appeal is unsuccessful?
The reference scheme test applied to salary-related contracted-out schemes from April 1997 to April 2016 so the period for consideration is amendments to your scheme rules during this period. However in Virgin Media it was taken as read that the amendments made in 1999 that were void due to the lack of a Section 37 Confirmation, ceased to be void when a new 2010 trust deed and rules (which included the 1999 amendments) was entered into, as a Section 37 Confirmation had been obtained in relation to those 2010 rules. This suggests that a new trust deed and rules containing the void amendments and accompanied by a Section 37 Confirmation will be sufficient to close the "window" with the amendments being effective from the date of the Section 37 Confirmation.
Arguably, the provision of a Section 37 Confirmation in relation to any subsequent amendment could work in the same way, even if that new amendment does not itself refer to the void amendments. However, this is far from certain, as it seems likely that the regulation 42 requirement for the actuary to consider "the proposed alteration" would not be complied with in relation to the void amendments in such a case – the actuary would simply be considering the new amendments and their impact on the scheme's compliance with the reference scheme test.
Perhaps more hopeful is the possibility that the actuary's triennial re-certification that the scheme meets the reference scheme test automatically closes the window. This re-certification process required the actuary to assess the scheme as a whole, and arguably that assessment would have included any amendments which had been made since the last re-certification (even those which turn out to have been void due to the absence of a Section 37 Confirmation). This question may be considered by the courts during the appeals process for Virgin Media, since it could help to shorten the "window" during which the amendments were void.
What form must a Section 37 Confirmation take?
Finally, it is worth noting that the Virgin Media judgment did not consider the evidential threshold for the existence or otherwise of a Section 37 Confirmation. For example, it may be possible to rely on minutes of a trustee meeting in which the actuary discussed the proposed amendments even where there is no evidence of a written Section 37 Confirmation (as required by the legislation).
Next steps for Virgin Media
Following the judgment, a further short hearing is to take place before the end of July, at which the parties are expected to put forward details of further issues they have identified in light of the judgment, for the High Court to consider. These could include, for example, questions around the closing of the "window" during which the 1999 amendment was ineffective.
It is expected that the decision will be appealed, and it may be that permission to appeal will be granted by the High Court judge at that July hearing. Otherwise, we would expect her to set a deadline for the parties to apply to the Court of Appeal for permission to appeal.
Next steps for pension scheme trustees
If your scheme was contracted out on a salary-related basis from April 1997 to April 2016 and you have made amendments during this period – these could be void. If so, trustees have probably been paying out incorrect benefits, and continuing to do so for a further brief period is inevitable particularly as the forensic work will take time (hence cost). Given that there is a reasonable prospect of the Virgin Media decision being successfully appealed we would advise waiting until we have a final outcome before commencing any investigation into your historic amendments.
The exception to the "wait and see approach" is cases where your scheme is in the final stages of a buy-out process where it is imperative that trustees buy the correct benefit in order to receive a statutory discharge from further liability. If your scheme is in that position your usual contact in the Pensions team will advise on suitable steps but if you would like more information on this decision, please get in touch with your Pensions team contact or Naomi Jacques: email firstname.lastname@example.org or direct line +44(0) 191 2799 701.