Bridge too far? DWP set to legislate

Introduction

The Supreme Court’s decision in the Bridge Trustees case1 was published on 27 July 2011. It addresses the dividing line between DB and DC benefits. How the benefit is classified makes a difference to the protections afforded by legislation. For this reason the Government intervened in the case, sponsoring the appeal first to the Court of Appeal and then on to the Supreme Court.

In this Alert:

• Key points
• Background
• Can DC benefits create a deficit?
• DC benefits with a guaranteed investment return
• DC internal annuitisation
• What next?

Key points

• The Supreme Court concluded that both DC benefits with a guaranteed investment return and DC “pots” which are converted into a pension within a scheme (known as internal annuities) fall within the statutory definition of “money purchase benefits”
• The DWP has issued a statement confirming that, as a result of the decision, it will introduce retrospective legislation which “will make it clear that benefits cannot be regarded as money purchase benefits if it is possible for a funding deficit to arise in respect of any of those benefits”.

Background

When the winding-up of the Imperial Décor Pension Scheme (the Scheme) began in October 2003 it had a £40 million deficit. Originally a DB scheme, changes over the years had resulted in a varied and complex benefit structure. The original application to the Court was brought by the Scheme’s trustees to determine how the statutory priority order2 on winding-up should be applied to the Scheme.

The priority order establishes priority for payment where a scheme winds up in deficit. Where DB assets are insufficient to satisfy all the liabilities in a particular class they are applied across the whole class and any lower ranking class remains unsatisfied. Under the relevant legislation, “money purchase benefits” fall outside the statutory priority order.

Can DC benefits create a deficit?

The two benefits at issue in the appeal to the Supreme Court were not obviously DB or DC. They were:

• a money purchase benefit with a guaranteed investment return; and
• a pension benefit purchased in the scheme with a money purchase “pot” (known as an internal annuity).

In both cases a deficit could arise in the Scheme as a result of the provision of these benefits. The Government considered both these benefits to be DB in nature – as its view is that a money purchase benefit can have no mismatch between assets and liabilities. The Supreme Court disagreed.

DC benefits with a guaranteed investment return

The Supreme Court concluded that DC benefits with a guaranteed investment return could be “money purchase benefits” for the purposes of pensions legislation. While the statutory definition requires such benefits to be “calculated by reference to a payment or payments made by the member or by any other person in respect of the member” it does not require such benefits to be calculated only by reference to those payments, making these benefits capable of being DC.

DC internal annuitisation

The Supreme Court decided that DC internal annuities may also be characterised as DC not DB, both the investment and longevity risk being retained within the Scheme. Further, the use of annuity tables based on actuarial calculations to convert a member’s defined contributions from a lump sum into an annuity did not change the nature of the benefit from DC to DB.

What next?

The DWP has issued a statement which explains that it intends to introduce retrospective3 legislation which will ensure that benefits which may create a funding deficit may not be classified as “money purchase”. It is particularly concerned that members with these types of benefits may not have the advantage of protective legislation, such as scheme funding, employer debt, the PPF and FAS.

The DWP states that it wants to provide certainty, ensure appropriate protection for scheme members’ benefits, and ensure that the UK complies with its obligations under European law.4 The Government will also consider transitional protection in respect of events occurring between the date from which the legislation is effective and the date of this statement if, for example, a retrospective change would have “adverse consequences” for individuals.

1 [2011] UKSC 42
2 The case concerned the pre-2005 statutory order of priority on winding up – see summary table
3 To at least the date of the judgment
4 Including the Insolvency Directive which requires protection for employees of an insolvent company and the Pensions Directive from which stem our statutory funding requirements.