In our July 2008 update and August 2009 briefing, we reported on the High Court decision that a revised benefit structure introduced to a defined benefits (final salary) scheme some years previously contained a defined contribution (money purchase) element, ruling against the members who claimed that the top-up benefits were final salary in nature. Section 73 of the Pensions Act 1995 (Section 73) sets out the priority order in which a pension scheme’s assets should be applied to pay pensions and other benefits in winding-up. Money purchase benefits are generally excluded from the pool of benefits taken into account when Section 73 priorities are decided. This case considered various benefits under the hybrid scheme in question and ruled on which should be “money purchase benefits” and thus fall outside the Section 73 priority order.

The case was taken to the Court of Appeal (CA) in June 2009 and judgment was handed down on 4 March 2010). The CA upheld the High Court’s decision that certain top-up benefits in a hybrid scheme were money purchase in nature, despite the use of actuarial factors in their calculation. These benefits were therefore not to be included in the winding-up process of the scheme.

The Department for Work and Pensions (DWP) intervened in the appeal as it was concerned that the High Court judgment could mean that the UK may have implemented incorrectly two EU directives (the CA case is called Houldsworth v Bridge Trustees)(1) & Yates and the Secretary of State for Work and Pensions (2) following the DWP’s intervention). The DWP’s claimed that the guaranteed investment returns and the scheme’s internal annuitisation process caused the relevant benefits under the scheme not to be money purchase benefits.

The Court of Appeal’s decisions

The CA decided as follows:

  • The DWP’s interpretation of the statutory definition of “money purchase benefits” and its argument that a scheme providing such benefits cannot have a deficit was rejected. The CA held that the High Court judge, Miss Sarah Asplin QC, had been correct to distinguish the CA decision in Aon Trust Corporation v KPMG [2005] and said that the correct way to construe the definition of money purchase benefits was “in a fair and sensible way” and then to apply it “sensibly to the provisions of the particular scheme, construed in their context”.
  • The internal annuitisation process (meaning that, when the pension became payable, the money purchase “pot” for the member was converted into a pension payable from the scheme, using factors as advised by the scheme’s actuary) had not caused the benefits from which the pension was derived to cease to be money purchase benefits.
  • Where money purchase benefits are used to pay defined benefit underpin benefits such as a guaranteed minimum pension (GMP), they are still money purchase benefits, but are categorised as “underpin benefits”, and so fall within the Section 73 priority order. However, money purchase benefits accruing after 5 April 1997, after which GMPs no longer accrued, were not available to meet the payment of GMPs, were not “underpin benefits” and fell outside the ambit of Section 73.
  • Benefits derived from the employers’ contributions which matched the members’ voluntary contributions were benefits “derived from” those voluntary contributions. Therefore, the CA held that these benefits came first in the Section 73 priority order, and “as a matter of simple fairness” could not be used to cross-subsidise the benefits of members who had not made voluntary contributions.

Comment: This case considered the pre-6 April 2005 winding-up priority order, which has now changed. Nevertheless, the analysis of the definition of money purchase benefits and the ranking of matching voluntary contributions is relevant for other schemes.

The CA interpreted money purchase benefits under Section 73 quite broadly, although it did emphasis that its decision was for Section 73 purposes only and not an all-encompassing definition of money purchase benefits.

For the DWP, the decision that internal annuitisation did not cause the related benefits to cease to be money purchase benefits, means that certain benefits it had previously considered to fall within the scheme funding regime may now fall outside it. The impact of this part of the decision is that the UK may not have implemented properly the EU Insolvency Directive and the Pensions Funds Directive. The DWP is expected to appeal the decision to the Supreme Court.