Court of Appeal decision in Virgin Media case - more potential uncertainty for pension schemes and their employers

On 25 July, the Court of Appeal returned a decision in the Virgin Media Ltd v NTL Pension Trustees II case. The Court’s judgment has potentially far-reaching consequences for employers in the UK that sponsor defined benefit (DB) pension schemes. 

Law  

The issues in the Virgin Media case dealt with contracted-out pension scheme benefits and the statutory requirements for making changes to those benefits.

From 6 April 1997 to 6 April 2016, defined benefit pension schemes could opt to ‘contract-out’ of the State Second Pension. Contracting-out required schemes to provide members with benefits that were ‘broadly at least as good’ as the pension benefits under the additional State Pension; in return scheme members and the sponsoring employer would pay National Insurance Contributions at a reduced rate. From 1996, the benefits of the members that were contracted out became known as ‘section 9(2B) rights’, referring to the section in the legislation that set out the requirements for contracting-out. 

Section 37 of the Pension Schemes Act 1993 (s37) relates to a scheme’s ability to change the section 9(2B) benefits that members were entitled to – it provides that the rules of schemes that had contracted-out member benefits cannot be changed or altered unless the requirements in the regulations are met. Regulation 42 of the Occupational Pension Schemes (Contracting-out) Regulations 1996 (Regulation 42) requires that schemes obtain actuarial advice confirming that proposed amendments to the scheme rules that would alter section 9(2B) rights met the statutory standards. These “Section 37 Confirmations” played a key role in the issues of the Virgin Media case.

Facts

In 1999, the NTL Pension Plan executed a second trust deed and rules, for which the scheme should arguably have obtained a Section 37 Confirmation because the change affected the section 9(2B) benefits payable to members under the scheme. The Section 37 Confirmation for this change could not be found, and the case moved forward on the assumption that the scheme had not obtained the confirmation at the time. 

Later, in 2010, the scheme trust deed and rules were changed again. This new trust deed and rules contained a provision on the revaluation of member benefits that provided for benefits to remain on the levels established by the 1999 trust deed and rules. The scheme did obtain a Section 37 Confirmation in respect of this deed, but the issue remained that the amendment was based on a previous change that may not be valid. 

The question that was posed to the High Court was as follows: could the changes made to the 1999 trust deed and rules be valid and effective without a Section 37 Confirmation? 

High Court decision

The judge in the High Court case held that the legislation at the time of the changes to the trust deed and rules was clear – schemes were required by law to obtain actuarial confirmation regarding amendments that altered section 9(2B) rights, regardless of whether those changes had an adverse effect on benefits. The NTL Pension Plan and Virgin Media could not produce this confirmation and therefore the changes in the 1999 trust deed and rules that reduced benefits and the changes to the 2010 trust deed and rules that were based on this reduction were invalid. 

The court held that, for the benefits accrued during the period between the two trust deeds and rules, the scheme liabilities should be increased to reflect what member benefits would have been had the amendments not been carried out. The cost of the increase was estimated to be £10m. 

Court of Appeal decision 

Virgin Media appealed the High Court’s decision on the grounds that s37 did not actually operate to invalidate the changes made to the 1999 trust deed and rules, that s37 only applied to benefits earned by service prior to the changes, and that s37 only applied to changes that adversely changed section 9(2B) rights. 

The Court of Appeal dismissed Virgin Media’s appeal.  The judges agreed that the wording of the law is very clear – there is nothing in s37 or Regulation 42 that would allow changes like the ones made by the scheme in 1999 to be valid without the required confirmation. The Court also held that section 9(2B) rights included both past and future service rights, meaning that s37 would apply even though the changes made to the 1999 trust deed and rules only applied to benefits accrued after the date of the deed. Finally, the court held that s37 applied to all changes made to scheme rules which affected contracted out rights, whether they were adverse or not. 

Implications

The Court of Appeal’s judgment has wide ranging consequences. Essentially, amendments made to defined benefit pension scheme trust deeds and rules that affected contracted-out rights will be void if the scheme did not, at the time of amendment, obtain a Section 37 Confirmation.  This will be an issue if the scheme cannot find the confirmation, or any sufficiently clear evidence it was obtained. 

If the decision stands, it may impose an administrative burden on schemes, as trustees and sponsoring employers may be advised to look back through archival files to verify if they obtained, and can find, the relevant Section 37 Confirmation (in particular, in relation to historical material benefit change exercises). If any purported change is void, the scheme may also have to revisit benefits paid out and make backdated payments to members.

Depending on the nature of the amendments, there may be a material increase in the value of the scheme liabilities – and depending on how well funded their scheme is, sponsoring employers may be required to pay increased contributions to make up the difference. 

Next steps

It is too early to know for sure whether the decision will be appealed, but there are no immediately obvious grounds for appeal. 

It is also too soon to say what the reaction of the new Labour government will be.   A joint statement has been issued by the Society of Pension Professionals, the Association of Consulting Actuaries and the Association of Pension Lawyers confirming that they have made a proposal to the DWP that the DWP introduce regulations to allow retrospective validation of amendments affected by the decision. This would mean that, subject to appropriate safeguards, any amendment that is now deemed void solely due to the absence of an actuarial confirmation would remain valid. There is already a regulation making power in the Pension Schemes Act 1993 so there is likely no need for primary legislation, and regulations could be made at pace – although in this context we also note that there will be a Pension Schemes Bill later this year.

The DWP already has a lot on its plate, but this decision could load costs and a significant administrative burden on pension schemes and their sponsoring employers at a time when the new government is expecting them to make other significant changes to support its UK investment and growth agenda.  We can only hope that they will be able swiftly to decide whether to accept the suggestion made to them.

The trustees and employers of contracted out schemes might begin looking at amendments made to their rules since 1996, particularly amendments reducing benefits, to check whether the required confirmations were obtained.  This would be particularly relevant to schemes with an actuarial valuation in progress or imminent, or employers finalising their accounts or preparing for a de-risking transction, since it will be important to ensure the correct liabilities are taken into account or appropriate provisions made. However, for many schemes it may be better to hold off on a full investigation until we have more clarity as to whether the government would be prepared to legislate to resolve the problem.

If you would like to discuss in further detail any of the points raised in this blog post, please contact your usual Freshfields contact.