Bridge over Troubled Waters – Protecting DC benefits

Introduction

If an underfunded scheme goes into wind-up or enters a PPF assessment period, DC members of hybrid schemes generally expect that their benefits (technically, money purchase benefits1) will be fully protected and will not fall into the general asset pool. But what benefits might count as DC has recently been the subject of the Court of Appeal’s decision in the Bridge Trustees case.2In an unusual move, demonstrating the importance of the issues raised, the DWP intervened in (and paid the costs of) the appeal.

Background

When an underfunded scheme with DB benefits goes into wind-up the statutory order of priority applies. The order establishes payment priority where there is “competition for payment”. The statutory priority order has changed a number of times – most recently on 6 April 2005, to reflect the introduction of the PPF.
DC in the order of priority

The statutory priority order does not apply to a scheme with DC benefits only, as the general assumption is that there is no mismatch in funding. But the position of a hybrid scheme3 is more complicated, and what benefits count as DC under such a scheme(and therefore fall outside of the statutory priority order) has been a live issue for some years.4

The Bridge Trustees case

This case concerned the pre-2005 statutory order of priority on winding-up.

At the time the Imperial Home Décor Pension Scheme (the Scheme) began winding-up in October 2003, it had a £40 million deficit. Although originally a DB scheme, earlier changes to benefits had resulted in a complex benefit structure. For example, certain DC benefits came with the benefit of a DB guarantee and some were contracted-out on a GMP basis prior to 6 April 1997.

In order to apply the statutory priority order, the trustees needed to determine whether certain benefits payable under the Scheme were “money purchase benefits”. If not, they could be used to subsidise the DB funding gap. The structure of the Scheme, and in particular the dearth of original scheme documents, made this difficult to assess.

The Court of Appeal

Given the complexity of the case it was hardly surprising that the High Court’sjudgment (made as long ago as May 2008) was appealed. The Court of Appeal decided the following in relation to the different benefits under the Scheme:

voluntary contributions (which are given priority under the pre-2005 priority order) included not only the individual’s AVCs but also the employer’s matching contributions;
DC benefits which were provided with a notional rate of investment return were still DC;
although DC benefits were secured within the scheme at retirement (by applying actuarial conversion factors) they were nonetheless DC in nature;
the fact that some DC benefits included DB guarantees did not prevent them from being “money purchase benefits” under the relevant legislation;
benefits of DC members with GMPs were essentially split into two parts:

in respect of pre-6 April 1997 accrual, the GMP was regarded as an underpin benefit for the purposes of the winding-up legislation, with that part of the DC pot therefore falling within the statutory priority order;
in respect of service on or after 6 April 1997 (when GMPs ceased to accrue), benefit accrual was treated as DC with no underpin, and so excluded from the general asset pool.

DC or not DC?

When it comes to assessing what constitutes a DC benefit, following the Court of Appeal’s decision, we are now entering more navigable waters. Although the Court’s conclusions may be generally applicable, the case was decided on a previous statutory priority order, which does not reflect the existence of the PPF.

Whilst DC members of hybrid schemes will be relieved that, in most cases, their DC benefits are likely to be protected against use in the general pot on distribution of assets when a scheme is winding-up, the view from (the) Bridge is that this may well ultimately depend on a scheme’s particular structure.

Trustees may wish to examine their scheme rules now to ensure that they understand what implications this case may have for their own scheme in the future.

1 “Money purchase benefits” are defined in the Pensions Schemes Act 1993 as “benefits the rate or amount of which is calculated by reference to a payment or payments made by the member or by any other person in respect of the member and which are not average salary benefits”
2 Houldsworth v Bridge Trustees, Court of Appeal, [2010] EWCA Civ 179, formerly known as Bridge Trustees v Yates in the High Court
3 A scheme with both DB and DC benefits
4 This issue was also previously discussed in particular in Aon Trust v KPMG [2006] 1 WLR 97 – for a summary of the case, click here