The Court of Appeal ruling in the Bridge v Yates case has been upheld by the Supreme Court. The Supreme Court looked at the definition of money purchase benefits and decided that the statutory definition does not require the rate or amount of benefits to be calculated only by reference to contributions. The court found that a Guaranteed Interest Fund mechanism (under which a deficit may arise should the actual investment return on contributions produce less than the guaranteed rate of return) and/or using internal annuities did not prevent the benefits in question from being classified as money purchase benefits.

The case is of widespread interest because the nature of benefits determines the statutory provisions applicable to a scheme. This is especially relevant where a scheme provides defined benefits alongside what it considers to be money purchase benefits, as was the case here. The Department for Work and Pensions (DWP) has taken an interest in the case because the potential for a gap between liabilities and assets in respect of money purchase benefits means that members could end up with underfunded benefits but without any protection under the Financial Assistance Scheme (FAS) or the Pension Protection Fund (PPF) either.

How were benefits structured?

The Imperial Décor scheme underwent a number of changes to its benefit structure. The structure went from pure defined benefit (DB) to DB plus extra contributions from members wishing to take up that option (matched, partially or wholly, by employer contributions), known as Voluntary Investment Planning (VIP).

Some years later, another section was introduced called MoneyMatch, the total contributions from which were credited to a Guaranteed Interest Fund 'GIF'. Under the GIF, the member would be allocated an annual return. The annual return would be set each year by the trustee by reference to building society rates, plus a possible bonus (based on a comparison of average investment returns over the last three years with average returns during the year in question). The structure of the GIF therefore meant that the member's interest would not reflect the actual investment return.

The VIP and MoneyMatch benefits were provided through internal annuities.

The Supreme Court was asked to assess whether the MoneyMatch benefits were money purchase benefits and whether benefits provided via internal annuities were prevented from being classed as money purchase in nature.

What did the Supreme Court consider?

The absence of lifeboat coverage

The DWP voiced concerns about the fact that money purchase schemes could, in certain situations, become underfunded and yet fall outside the protection afforded by the FAS/PPF. Lord Walker pointed out that courts have to decide issues of construction as a matter of principle, without regard to the practical consequences.

The lifeboat protections, in the form of the FAS and PPF, stem from European Directive requirements. The Court was therefore asked to consider whether any drafting error might amount to a 'grave and manifest breach of Community law' (the DWP cited the principle that courts should prefer a construction avoiding infringement or possible infringement of EU obligations). The fact that the vast majority of money purchase scheme members would be unlikely to need lifeboat help meant that the DWP's arguments on this front were not accepted.

KPMG distinguished

The other case examining the nature of money purchase benefits was that relating to the KPMG scheme, which went as far as the Court of Appeal. The benefits there were based on defined contributions, but actuarial formulae were applied so that the amount of pension earned by any member was capable of being ascertained year by year. In other words, each year's contributions produced a provisional component of the pension - an approach described as 'building blocks'.

It was found that the introduction of actuarial factors broke any direct relationship between the contributions and the benefits. Added to this, the benefits were then capable of adjustment, where the fund was found to be in surplus or in deficit (the trustees had power to make this adjustment with the principal employer's consent). In the KPMG rulings, the 'contingent and discretionary' effect of these powers on benefits was found to be inconsistent with their being money purchase benefits.

The KPMG benefits were therefore somewhat different from those in the Imperial Décor scheme. The actuarial formulae and width of the surplus/deficit adjustment powers produced, in Lord Walker's words:

"...too wide a discontinuity between the quantum of a member's total contributions (and the return on them), on the one hand, and the benefits to which the member would eventually become entitled, on the other hand".

Do money purchase assets and liabilities have to match up?

The argument that the assets and liabilities in a money purchase scheme must be in alignment was rejected, although it was acknowledged that that would be the case in typical money purchase arrangements and that the legislation had been put together with that assumption in mind.

What does "calculated by reference to" mean?

The Court examined the statutory definition of money purchase benefits contained in the Pension Schemes Act 1993:

"'Money purchase benefits' ... means benefits the rate or amount of which is calculated by reference to a payment or payments made by the member or by any other person in respect of the member and which are not average salary benefits".

The Court of Appeal in KPMG decided that the words "calculated by reference to" within that definition meant "calculated only by reference to". Although the Supreme Court in Bridge felt that the KPMG case had been correctly decided, it did not agree with the Court of Appeal's conclusion on this point in the KPMG case.

The Supreme Court noted that the statutory definition did not refer to investment return. A 'pot' of contributions plus, say, annual interest would be just as much "calculated by reference to...payments" as a pot reflecting actual investment returns. It therefore followed, in the Supreme Court's view, that the GIF mechanism in the Imperial Décor scheme did not unhitch a member's benefits from contributions made. The GIF provided for a yield of guaranteed interest, plus possible bonuses, at a modest rate fixed by an objective test. This was in stark contrast to the "much looser terms" of the discretionary surplus/deficit powers in the KPMG scheme.

Internal annuities

The Supreme Court decided that internal annuities were not incompatible with money purchase benefits. This was implied by the legislation and to find otherwise would "produce insupportable anomalies". The annuity tables were used only when the member retired and that was no different from annuities provided by a life office.

Winding up hybrid schemes

Although the Supreme Court had not been asked to look at this issue, Lord Walker felt it would be unfortunate not to comment on the carve-out of money purchase benefits from the statutory priority order applying to hybrid schemes in wind-up (set out in regulation 13 of the Occupational Pension Schemes (Winding Up) Regulations 1996). The legislation carves out the liabilities and assets "by reference to which the rate or amount of [money purchase] benefits is calculated". Lord Walker's view was that, in the case of the Imperial Décor scheme, the assets to be carved out should be equal to the value of money purchase benefits calculated by the GIF mechanism.

What does this ruling mean?

  1. The Supreme Court's ruling recognises that, while the vast majority of money purchase schemes are straightforward, there are more complex arrangements (where a mismatch between assets and liabilities could occur) which are providing money purchase benefits too.
  2. People running hybrid schemes will need to consider their scheme's status in the light of this judgment. It would appear that the degree of integration of any elements that might be considered to break the link between contributions and benefits will be key to such analysis. Any conclusion on this point will be subject, however, to whatever legislation the Government decides to issue on this.
  3. The Government needs to ensure that it complies with European laws on the security of members' benefits. The DWP's involvement in this case stems from concerns about the adequacy of the UK's compliance, since members of underfunded money purchase schemes fall outside the protections afforded under the FAS/PPF. The Government's announcement that it intends to introduce legislation treating those sorts of scheme as not money purchase is an attempt to address this concern.
  4. Schemes affected by the amending legislation will face additional legislative and regulatory burdens.
  5. The Government's response should mean lifeboat coverage for the members concerned (although the period of accrual from which that coverage will become available is not clear). According to the press release, the legislation "will have retrospective effect at least from the date of the judgment", with transitional protection to be considered "in respect of events occurring between the date from which the legislation is effective and the date of this statement if, for example, this retrospective change would have adverse consequences for individuals".