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PPF to doff its compensation cap

On 22 June 2020, the High Court ruled in Hughes v Board of the Pension Protection Fund that certain restrictions applied to benefits paid from the Pension Protection Fund (PPF) are unlawful on age discrimination grounds.

Background: PPF compensation

Members of eligible defined benefit pension schemes with an insolvent employer will receive compensation from the PPF if the scheme’s assets (including any recoveries made from the employer) are insufficient to cover PPF compensation levels. Members who are older than the pension scheme’s normal pension age (NPA) at the time of the insolvency (or who have taken ill-health early retirement) will receive a pension based on 100% of the pension they would have received from the scheme, subject to statutory limits on future pension increases. For members who are under NPA at the time of insolvency:

  • their pension on retirement is based on 90% of the amount of pension they would have received from the pension scheme,  and
  • benefits payable from the PPF are also subject to an overall cap, which varies depending on the age of the member at retirement.

CJEU decision in Hampshire and subsequent judicial review

In September 2018, the Court of Justice of the European Union (CJEU) issued its ruling in the Hampshire case, confirming that EU member states (which included the UK at the time) must guarantee that pension scheme members receive at least 50% of their accrued pension benefits after the insolvency of their former employer. Since this ruling, the PPF cap has been applied subject to this 50% underpin, which the PPF assesses by comparing the actuarial value of the member’s PPF compensation and the pension he would otherwise have received from the pension scheme.

Following the CJEU’s decision, a number of claimants, including Mr Hughes, issued judicial review proceedings about other aspects of the way PPF compensation is calculated, including challenging the validity of the cap itself. Mr Hughes had taken early retirement on a pension of around £66,000. The pension scheme’s sponsoring employer subsequently became insolvent and the scheme went into the PPF. Because Mr Hughes was still below the scheme’s NPA of 60, he was subject to the compensation cap, and his pension was reduced to £17,481 (the level of the applicable cap at the time): a reduction of around 75%. Had Mr Hughes been a year older, his pension would not have been capped as he would have been over NPA at the time of insolvency. The claimants argued that treating younger pensioners less favourably than older ones was unlawful age discrimination.

The court upheld the claim, and ruled that:

  • The compensation cap constituted unlawful age discrimination.
  • It is for the PPF to decide how the overall compensation payable during retirement (or the lifetime of a survivor) will equal at least 50% of accrued scheme benefits. It is not necessary for the PPF to conduct an annual comparison.
  • Members of pension schemes in a PPF assessment period should receive benefits that meet the minimum benefit threshold set in Hampshire.
  • The PPF could limit arrears payments resulting from the removal of the compensation cap by reference to a six year limitation period in the Limitation Act 1980.

Comment

The 90% benefit limit and the overall compensation cap were designed to combat moral hazard by ensuring that the presence of the PPF did not act as a disincentive to funding a scheme properly. The compensation cap in particular was set at a level that was typically only expected to affect those in senior management roles, who were more likely to have a role in scheme funding. However, senior decision-makers are not by any means the only ones who have been affected by the cap. In fact, changes to the cap were introduced in 2017 to partially mitigate the effect it had on members whose benefits were large because of a long service history rather than management-level salaries. The Hughes decision will come as welcome news to those with significant benefits who have yet to retire, as well as those in receipt of capped compensation.

The PPF has issued a statement confirming that, notwithstanding the Hughes judgment, the government sets the level of compensation the PPF pays and the PPF will continue to pay members their current level of benefits whilst deciding its next steps and awaiting the response of government to the ruling. It is unclear how long this will take.

The PPF is considering with government how the six year limitation period should apply to schemes in the PPF. In the meantime, the PPF has confirmed in an FAQ document that it will not “without further notice” treat time as continuing to run from 22 June 2020 (the date of the Hughes judgment) so, unless the position changes, the intention is that no PPF members who are subject to the cap will be prejudiced by not making a legal claim for arrears now. Further consideration will also need to be given to how the limitation rules apply to schemes which have been in PPF assessment for more than six years, and to the application of the ruling to schemes which have wound-up or are winding-up outside of the PPF following a PPF assessment process.

Given that the compensation cap currently affects a very small minority of members, the PPF’s chief actuary commented in the case that the removal of the cap would have no immediate and directly discernible impact on the rate at which the PPF levy is set. That said, it is possible that some pension schemes will see their PPF levy increase in future if their membership includes a high proportion of members with benefits above the compensation cap.

© Copyright 2022 Squire Patton Boggs (US) LLPNational Law Review, Volume X, Number 205
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About this Author

Alexandra Heggie Pensions Attorney Squire Patton Boggs Law Firm
Associate

Alexandra joined the Pensions Practice Group as an associate in 2012, having trained with the firm.  During her training, she completed a four-month secondment at the Paris office.

She has experience of advising both individual and corporate trustees and sponsoring employers on a wide range of aspects of occupational pension plans including governance, legislative compliance, plan documentation and member queries relating to both defined benefit and defined contribution arrangements.

+44 121 222 3115
Philip Sutton, Estate Attorney, Squire Patton Boggs
Partner

Philip has over 20 years’ experience advising corporate sponsors, trustees and others on a wide range of issues relating to UK pension plans. He regularly helps clients to establish, change or close their pension plans as well as assisting on a wide range of compliance and day-to-day advisory issues.

+ 44 121 222 3541
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