This briefing looks at the recent consultation document issued by the judges of the Employment Tribunal on compensation for the loss of pension rights. This aims to update the similar guidance last issued in 2003. The aim is to help parties to claims in the Employment Tribunal on the issues arising in relation to pension loss.
The consultation document proposes various changes to the previous guidance in the light of general changes to pensions rights:
- no compensation for the loss of accrual of state pension;
- generally no compensation for loss attributed to service before the date of dismissal (as this will usually be covered by revaluation under the pension scheme (and there is a statutory minimum rate of revaluation);
- a “simplified” loss method, based on employer future service contribution rates, to apply in most cases for loss of pension benefit for service after dismissal. In particular where existing pension accrual is on a defined contribution (DC) or money purchase basis; and
- in more complex cases (e.g. where the claimant is entitled to defined benefit (DB) accrual before loss of employment), the parties may seek either to use the “Ogden tables” or to produce actuarial evidence of the value of the lost benefits.
As previously, the new guidance will not be binding on the parties or the tribunal. Instead it will usually operate as a presumption to be applied unless a party successfully argues otherwise.
In 1991, the employment tribunal judges and the Government Actuary's Department (GAD) first published a guidance booklet, “Compensation for Loss of Pension Rights: Employment Tribunals”. This offered guidance to the parties (and the tribunal), on the calculation by the Employment Tribunal of compensation to reflect lost pension rights following termination of employment. The third and most recent edition was published in 2003 (the 2003 Guidance). Various cases have commented on how useful the guidance is.
In 2014 in Griffin v Plymouth Hospital NHS Trust1, Underhill LJ observed that in the intervening years, changes in the pensions landscape had rendered the application of the 2003 Guidance inappropriate, and he called for an update.
In March 2016, a working group of Regional Employment Judges and Employment Judges produced, in response, a consultation paper on the new approach to be adopted in calculating lost pension rights (the 2016 Consultation). GAD was not involved.
Tribunal pension claims
Both the 2003 Guidance and the 2016 Consultation relate to the calculation of compensation for pension loss in claims before the Employment Tribunal. In practice this covers claims for:
- unlawful discrimination (Equality Act 2010); or
- unfair dismissal (Employment Rights Act 1996).
These claims are both, in essence, statutory torts. The aim is to compensate the claimant for the loss suffered.
In contrast claims based on breach of contract are usually heard by the county court or High Court (rather than the Employment Tribunal) and any damages awarded will, on usual contractual principles, be limited to the quantum of loss incurred over balance of the employee’s contractual notice period (and probably not include any allowance for potential future pay rises over that period).
In unfair dismissal claims, the Employment Tribunal may award a claimant a basic award (calculated in accordance with a statutory formula) and a compensatory award (which is such sum as the Employment Tribunal considers “just and equitable” in all the circumstances). The total award in unfair dismissal cases is subject to a statutory cap (set at £78,962 for the 2016/17 tax year or, if less, 52 weeks' pay).
Only a presumption or default position
The 2003 Guidance and the guidance which the 2016 Consultation seeks to introduce are not binding. It is open to the parties in any Employment Tribunal proceedings to argue that an alternative approach is more appropriate in the circumstances.
What was the approach in the 2003 Guidance?
The 2003 Guidance addressed the potential for loss:
- in relation to State pension benefits; and
- under occupational pension schemes.
In relation to State pensions, the default assumption was that a claimant would incur no loss in relation to basic state pension benefits. However, if he or she were not a pension scheme member, or were a member of a contracted-in pension scheme, then losses may be incurred in relation to the additional state pension (in the form of the Graduated Retirement Benefit, State Earnings-Related Pension Scheme or State Second Pension). Occupational pension schemes
In relation to losses associated with occupational pension schemes, the 2003 Guidance advocated the use of two approaches: the “simplified” approach or the “substantial loss” approach.
The simplified approach
Assessment of loss using the simplified approach involved a three-stage assessment of:
- loss of enhancement to rights accrued prior to dismissal;
- loss of rights between the date of dismissal and the date of the hearing; and
- loss of future pension rights beyond the date of the hearing.
A timeline shows this:
Click here to view image.
The simplified approach was used in all DC cases, but could also be used in relation to some DB cases.
Loss of enhancement of accrued rights
By leaving a final salary occupational pension scheme early (by reason of dismissal), an individual becomes a deferred member, and loses the link between the benefits which he or she has accrued and a potentially higher final salary at the date which he or she would have retired (or left service). But the member does get the benefit of revaluation in deferment (with a statutory minimum level under the Pension Schemes Act 1993).
The 2003 Guidance recommended that no compensation be awarded in respect of this “loss of enhancement” if the individual was within five years of retirement or if the Employment Tribunal found that the individual would have lost his or her job in any event within one year.
If, however, the individual had five or more years to retirement, the 2003 Guidance recommended the application of a multiplier determined by the GAD to the value of the deferred pension at the date of dismissal to determine the value of lost enhancement. The resulting sum was reduced if the Tribunal considered that the individual’s employment would have been terminated within one year.
This head of loss would only be relevant in relation to loss of final salary pension rights.
Loss of pension rights following dismissal
In respect of pension rights lost between the date of dismissal and the hearing, and for any period beyond the hearing, the 2003 Guidance recommended that valuation be based on the amount of employer contributions which would have been made during the relevant period.
Adjustments in accordance with GAD multipliers were made to take into account the age of the individual in relation to the blended rate of the employer’s contributions (in DB cases), and accelerated payment (in relation to both DC and DB cases).
The substantial loss approach
The 2003 Guidance suggested that a different approach would be appropriate where there was an element of continuing loss to be valued. For example where the claimant was not likely to find new employment, or was not likely to find employment with a comparable level of benefits.
Where the substantial loss approach was considered appropriate, the 2003 Guidance recommended that loss be valued at:
- the total value of prospective final salary pension rights to retirement age but for dismissal; less
- the value of accrued rights and any prospective final salary pension rights.
Each value was then multiplied by a factor determined by the appended GAD tables.
What is the suggested new approach?
The 2016 Consultation proposes changes to the 2003 Guidance in a number of respects, however the most notable is the move away from the use of the GAD multipliers as a result of there being no funding available to get actuarial advice from GAD to update the assumptions underlying these multipliers. The 2016 Consultation suggests as an alternative the use of the “Ogden tables”. These are actuarial tables commonly used in the assessment of compensation in personal injury cases.
Under the suggested new approach, the default assumption would be that claimants incur no loss related to either basic state pension or additional state pension rights.
The 2016 Consultation, like the Guidance, suggests that there are two possible approaches to valuing pensions loss depending on whether a case is “simple” or “complex”.
Loss of both DB and DC rights could be considered under the simple approach. The value would be calculated using the amount of lost employer future service contributions from the date of dismissal (i.e. not including any deficit contributions).
Appropriate reductions would be made being made to reflect reasonable mitigation of loss – for example entry into new employment or the likelihood of such employment being obtained. As a result of the introduction of auto-enrolment, a minimum level of employer contributions would be assumed in any new employment (in practice this ought to be included as part of the total remuneration assessment in any event).
Accrued rights loss
A notable change in simple cases is that the 2016 Consultation suggests no compensation should be awarded in respect of lost enhancement of accrued rights. This is proposed as a default assumption because:
(a) it is no longer necessarily the case that earnings growth in the form of salary increases (which the claimant may have benefited from if his or her employment had continued to retirement) will necessarily outstrip pension growth in the form of the revaluation of deferred benefits under the pension scheme (which the claimant will benefit from following the termination of his or her retirement); and
(b) many final salary schemes are either being replaced with CARE schemes or being closed altogether, meaning that retention of the “final salary link” for the duration of an employee’s employment is no longer a safe assumption.
Consequently, the 2016 Consultation suggests that the presuming of a continued final salary link is no longer appropriate.
The 2016 Consultation anticipates that the use of the complex case approach would be rare, and in relation only to loss of DB rights for a substantial period of time, where no comparable benefits are likely to be obtained.
Complex cases would need to be identified early in order that separate hearings could be listed to address liability and remedy, with the latter being listed for two stages.
Following the establishment of liability, the first stage remedy hearing would deal with elements of non-pensions related loss (for example, the compensatory award in instances of unfair dismissal, or sums for unpaid holiday) and make findings of fact relevant to pension loss (for example, the relevant date of retirement, or prospects of promotion).
Following the first stage remedy hearing, the parties would be given a time-limited opportunity to agree the quantum of pensions loss.
If no agreement is reached, a second stage remedy hearing would be held. At this hearing, pensions loss would either be valued in a manner similar to that described in the Guidance, but either:
- applying factors set out in the Ogden tables rather than the GAD tables; or
- be valued pursuant to expert actuarial evidence. The use of expert evidence is expected to be highly unusual, and appropriate only in circumstances where significant loss is anticipated.
Summary of 2003 Guidance and 2016 Consultation approaches
Click here to view table.
In our view, claimants may still look to argue in some cases that the default position of awarding no consideration for lost enhancement of accrued rights was inappropriate. In practice it would be considerably easier for an employer to rebut an assumption of lost enhancement e.g. by referring to an ongoing consultation in relation to closure of a scheme, than for a claimant to demonstrate that his or her final salary link would be maintained.
We note that while the 2003 Guidance recommended the application of a GAD multiplier to employer contributions as part of the simplified approach to reflect the relationship between the claimant’s age and the blended employer contribution rate, there is no such adjustment in the new proposed method. This could incline towards the overcompensation of younger claimants, and the undercompensation of older claimants.
A difficulty with the use of the Ogden tables as a method of valuing loss in complex cases is that they do not account for potential future pay rises, and the 2016 Consultation suggests applying a discount rate of 2.5%. The discount rate is intended to reflect that the claimant is receiving an immediate lump sum, and has a period of time in which to realise investment returns before reaching normal retirement age.
However, as the 2016 Consultation acknowledges, 2.5% could be argued to be an optimistic rate of return in current economic conditions (although it is the one used in personal injuries cases, being set down by legislation).
Together with no provision for future pay rises, it could be argued in some cases that this could result in under-compensation in complex cases with a long period of loss.
Ultimately in many cases the tribunal takes a broad brush approach to fixing the levels of compensation. Trying to assess pension loss in a very precise manner may be costly and ultimately end up being just one factor in the total loss calculation. Other factors include:
- in some unfair dismissal cases, the ultimate award will be hit by the cap in any event;
- future loss, which is dependent on an estimate of how long it will reasonably take the claimant/employee to get a new job and what level of remuneration and other benefits are provided;
- how long the claimant/employee would have stayed in his or her existing job in any event (e.g. they may have voluntarily resigned in any event);
- whether the existing pension benefits could have changed in any event (e.g. employers are looking to close final salary accrual); and
- when the claimant/employee would have retired in any event (e.g. at state pension age – or perhaps, if earlier, the scheme's retirement date?).