UK Pensions – High Court confirms impact of final salary link on employer debts
The High Court has given judgment in a case (G4S plc v G4S Trustees Ltd) about whether a defined benefit (DB) scheme which was closed to future accrual, but whose members' benefits continued to be linked to final salary, was a "frozen" scheme for the purposes of the employer debt legislation. The Court has decided that the final salary link did not mean that the members were in pensionable service and, as a result, the scheme was frozen. This is important for employers (and trustees) of closed schemes where the members retain a final salary link. It means that employers of such members will not trigger an employer debt when they cease to employ those members. They will, however, remain potentially liable for an employer debt on insolvency or in the event of the scheme winding-up.
An employer debt will be triggered in relation to an underfunded multi-employer DB scheme if:
- the employer ceases to employ active members of the scheme at a time when at least one other employer continues to employ active members (this is known as an “employment cessation event”);
- the employer suffers an insolvency event; or
- the scheme winds-up.
In the case of frozen schemes, an employer debt will generally only be triggered in the latter two situations. The legislation defines a “frozen scheme” as a scheme which has ceased to have “active members”. “Active member” is defined as a person who is in “pensionable service” under the scheme. “Pensionable service” is defined as service in any description or category of employment to which the scheme relates which qualifies the member (on the assumption that it continues for the appropriate period) for pension or other benefits under the scheme.
In most cases, it will be clear that a scheme which is closed to future accrual is a frozen scheme for employer debt purposes. However, there has been some uncertainty about whether a continued link to final salary (or the retention of other rights) means that the members remain “active members” so that ceasing to employ those members could trigger an employer debt.
The implications for employers are significant: if an employer debt is triggered, an amount equal to the employer’s share of the deficit is treated as a debt due from the employer to the trustees of the scheme. The debt is calculated on the buy-out basis (i.e. by reference to the cost of securing benefits through the purchase of annuities and deferred annuities).
In 2015, the High Court decided (in Merchant Navy Ratings Pension Fund v Stena Line) that continued entitlement to an enhanced rate of revaluation following closure to future accrual did not mean that members were in pensionable service and, as a result, the scheme was frozen. The Court did not, however, consider whether the same conclusion applies to a scheme with continued final salary linkage.
The issue in this case was whether a member whose scheme was closed to future pensionable service, but whose past service benefits continued to be linked to future final salary, remained, as a result of that link to final salary, in "pensionable service" for employer debt purposes. The representative member argued that the final salary link meant that such members remained in pensionable service so that the scheme was not frozen.
The High Court has decided that the final salary link did not mean that the members were in pensionable service and the scheme was therefore frozen.
The Court said that the definition of pensionable service has two limbs: the first was the requirement for service in any description or category of employment to which the scheme related; the second was the requirement that it qualified the member for pension or other benefits under the scheme. Dealing with the second limb, the concept of pensionable service was not identical to the year-on-year accrual of pension benefits. However, it was clear as a matter of construction in the statutory context that where accrual had ceased, but final salary linkage remained, there was no pensionable service after the closure date. That was because there was no service under which pension benefits continued to accrue. The final salary link was a way of quantifying the benefit which had already accrued at the closure date. The distinction was between the accrual of benefits giving a prospective entitlement to pension and the quantification of those benefits. Post-closure service did not qualify for further pension but only affected its quantification by way of the final salary link.
This decision brings welcome clarity to a previously uncertain area of pensions law. Employers and trustees of closed schemes, where the members retain a final salary link, can now be confident that employers of such members will not trigger an employer debt when they cease to employ those members. They will, however, remain potentially liable for an employer debt on insolvency or in the event of the scheme winding-up.
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