The case of Bridge Trustees has re-examined and cast doubt over how the law defines what is a money purchase benefit and what is a final salary benefit, particularly in hybrid schemes where the lines between the two can be unclear. In response, the DWP is proposing to introduce new legislation to clarify the position, and this may mean that some money purchase arrangements will become subject to some or all of the legislation that applies to final salary schemes.
1. The Facts of the Bridge Case
1.1. The Bridge Case concerned an occupational pension scheme known as the Imperial Décor Pension Scheme (the “Scheme”) which had wound up with a deficit of £40 million. The Scheme originally provided final salary benefits only, however, through various restructurings began to include money purchase benefits for some members. The first restructuring introduced additional contributions by members which were known as VIP Benefits and were considered to be money purchase benefits by the Trustees. These were annuitised internally using tables of factors periodically supplied by the Scheme’s actuary. The second restructuring created a further tier of ‘Money Match’ Benefits. Money Match Benefits were also considered to be money purchase benefits, relying on contributions made on a member’s behalf, however, total contributions were credited to a Guaranteed Investment Fund (the “GIF”) whereby the Scheme undertook to provide a minimum guaranteed rate of return.
1.2. With a £40 million deficit in the Scheme on winding up, the statutory priority order was to come into play under section 73 PA 1995. The question essentially put before the court was whether or not the VIP Benefits and the Money Match Benefits were correctly treated as money purchase benefits. Being excluded from the section 73 priority order, this would mean money purchase members would receive the full benefits relating to their contributions. If not, these benefits would be subject to the priority order and the contributions would be shared amongst members along with other assets held by the Scheme.
2. Arguments Put Forward by the Secretary of State (DWP)
2.1. Following decisions at First Instance and in the Court Appeal to allow treatment of the VIP and Money Match Benefits as money purchase benefits, the Secretary of State on behalf of the Department for Work and Pensions joined the case in order to support the appeal against the previous judgements.
2.2. The main thrust of the argument put forward by DWP was based on the KPMG Case decision and was as follows:
2.2.1. The promise of future benefits is the hallmark of defined benefit schemes; the equilibrium of assets and liabilities is the hallmark of money purchase schemes and the reason why they are largely excepted from the operation of section 73 and 75 of PA 1995;
2.2.2. the Court of Appeal’s decision in the KPMG Case confirmed that a money purchase benefit should be the direct product of the contributions and calculated only by reference to the contributions; and
2.2.3. In this case the application of actuarial factors, internal annuitisation of benefits and the provision of a minimum rate of return meant that the benefits in question were not a direct product of the contribution and were calculated by reference to other factors. Due to the GIF, assets and liabilities in the money purchase section may not match. On this basis the VIP and Money Match Benefits did not fall within section 181(1) PSA 1993.
3. Decision and Findings of the Supreme Court
3.1. The Supreme Court upheld the decisions at First Instance and the Court of Appeal and went slightly further than just distinguishing the KPMG Case, overruling the judgement in part.
3.2. The Supreme Court differed from the proposition in the KPMG Case. It ruled that reference to “calculated by reference to” in the definition of money purchase benefits under section 181(1) PSA 1993 does not mean “calculated only by reference to” in the sense that the benefit in question must be the direct product of the contributions (as was held in the KPMG case). This narrowed the scope of the definition in the statute.
3.3. The KPMG case was correctly decided on its facts but distinguished on the basis that the methods of calculating benefits in the scheme in that case created too wide a discontinuity between the quantum of contributions and the benefits entitled to through actuarial building blocks being added into calculations each time a contribution was made and wide discretionary bonuses being applied.
3.4. In Bridge, the GIF mechanism did not unhitch a member’s eventual benefits from that member’s total contributions, it merely provided a yield of guaranteed interest, fixed by an objective test.
3.5. Further the application of actuarial factors and internal annuitisation in the Bridge Case was not inconsistent with money purchase benefits. While it is not necessary for a money purchase scheme to have an actuary, the use of actuarial tables were only used at the final stage, to calculate pension, rather than to project future benefits. The Supreme Court agreed with the deputy judge’s view that the distinction between internal and external annuities would produce insupportable anomalies.
3.6. Per Lord Mance’s dissenting judgement, a limitation on the above is that PSA 1993 will not be seen as embracing liabilities which are not matched with any specific asset held by a scheme within the definition of money purchase benefits under section 181(1). This will likely mean that where any money purchase section has deficient assets, the extent to which liabilities exceed assets will be outside the concept of money purchase benefits and fall within the funds available under the priority order of section 73 PA 1995.
4. Impact of the Decision in Bridge and the New Legislation Proposed in Response
4.1. The Bridge Case has exposed failings in the drafting of the legislation and the interpretive requirements that need to prop up the principles therein.
4.2. In relation to the revaluation of deferred pension this issue is likely to arise where a member challenges the basis on which his entitlement to benefits should be calculated. In contrast, winding up/section 75 debt cases such as Bridge and KPMG will more often involve a challenge by pensioner members who will have priority over deferred and active members and seek to improve the chance of recovering benefits by drawing the money purchase pot into the funds available to them. Alternatively, an employer may challenge its obligations to fund benefits by claiming that they are money purchase benefits and therefore outside the scope of section 75, as in KPMG.
4.3. The potential impact of the decision is difficult to measure, given the number of schemes with hybrid arrangements and the additional benefits and rules linked to money purchase sections is unclear.
4.4. Further, the case has not drawn a clear distinction to mark where the exemption from section 73 PA 1993 will end. This problem will apply also to revaluation of deferred pension under section 83 – 86 PSA 1993. Given this blurred concept, it would be wise for schemes to take care when offering any DB element to benefits (eg. In ill-heath or death benefit provisions). Essentially any salary related provision may push all benefits into the scope of the section 73 priority order.
4.5. Following the Bridge Case, the Department for Work and Pensions has issued a statement that the Government intends to draft legislation clarifying the dividing line in this area. It will take effect retrospectively from 27 July 2011 or earlier. The likely effect of the new legislation is that schemes will face a strict approach as Government’s intention appears to be that any schemes that can potentially have a funding deficit will no longer fall within the statutory definition of a money purchase scheme. The impact of the new legislation is unclear while it remains undrafted, however it seems likely that some money purchase schemes could become subject to some or all of the legislation that applies to defined benefit schemes.