Pensions Bulletin - February 2024

Quick read

In the latest edition of our Taylor Wessing Pensions Bulletin, we give a snapshot of some of the latest pensions developments from a legal perspective. These include:

Please get in touch with your usual Taylor Wessing pensions contact if you would like to discuss anything you have seen in the Bulletin.

Final DB scheme funding regulations

Of key importance to the trustees of DB schemes, the Government has now published the final version of its scheme funding regulations. These will come into force from 6 April 2024 and will apply to valuations from 22 September 2024. More on the basic framework behind the new scheme funding regime can be found here.

The final regulations differ from the previous ones issued for consultation in some key respects, including:

making clear that trustees can, in practice, invest in a way that is different from their statement of strategy (ie – the statement which trustees must prepare under the new regime which sets out the long-term funding and investment strategy for the scheme)
confirming that open schemes can take into account new entrants and future accrual in determining when the scheme will reach significant maturity
when considering deficit repair contributions, the impact on the sustainable growth of the sponsoring employer must also be taken into account alongside reasonable affordability. (This could provide useful flexibility for example where an employer has a window of opportunity to invest in its business).

TPR's scheme funding code will deliver final detail, for example around what is meant by 'significant maturity', and TPR has reportedly said that it expects the code to be in place in time for the first valuations that are subject to the new regime. Schemes with valuation dates soon after 22 September will need to start working with their advisers in plenty of time to ensure their next valuations comply with the new regulatory framework.

The Pensions Regulator publishes a report on its activities in relation to the Capita data breach

TPR has issued a regulatory intervention report to describe how it worked with Capita after the cyber data breach incident in March 2023, which is useful in identifying TPR's expectations about what schemes should bear in mind and have in place to manage any such incidents. Our report on some of the key takeaways can be found here.

Trustees' fiduciary duties and climate change – Financial Markets Law Committee (FMLC) publishes its report on trustee fiduciary duties, sustainability and climate change

The Financial Markets Law Committee has published a report covering fiduciary duties of pension scheme trustees and their decision-making in the context of sustainability and climate change. The report aims to reduce legal uncertainty in this area by exploring the scope of "financial factors", which should always be taken into account when making investment decisions, and which will include risks and opportunities arising from climate change and (legal, regulatory, behavioural and other) responses to it. The report recognises the role that pension schemes play as part of the wider financial and economic network, and that in addition to considering the possibility that climate change may be relevant to investment returns, trustees should bear in mind that strategies may be particularly vulnerable to the impacts of climate change.

The report is not binding on trustees, but it may prove a useful resource for developing their approach to climate risk in the investment context, particularly given that the General Code, due to come into effect on 27 March, says that trustees should have processes for identifying and assessing climate change risks and opportunities.

Recent cases: historic amendments to scheme rules

Trustees should be aware of two recent judgments, each of which touched on the impact of a restriction or "fetter" in the amendment power in the scheme rules. Cases on the validity of past amendments are, we expect, going to become more frequent, given the number of schemes now reviewing their benefits as part of their "endgame" planning, and we are aware of more such cases in the pipeline for 2024. These cases are noteworthy in that they can aid trustees of other schemes in interpretating their own amendment power wording and in determining whether past amendments could be treated as valid, in whole or in part. In particular, these two cases give a helpful steer as to how the courts will deal with amendments that break a final salary link where the scheme amendment power contains wording prohibiting this sort of change.

In Newell Trustees Ltd v Newell Rubbermaid UK Services Ltd, a change was made to the scheme rules in 1992, creating a new money purchase section. Members under the age of 40 were automatically transferred to the new section and their accrued final salary benefits were converted into a lump sum held in the money purchase section. Members aged between 40 and 45 were given a choice as to whether to transfer or remain in the final salary section, and members aged 45 and over remained final salary members. In addition to a question about the validity of the amending documents, the Court considered whether the link to final salary was validly broken when the conversion of younger members' benefits took place in 1992 and whether the difference in treatment of younger members amounted to unlawful age discrimination.

The amendment power in the scheme rules included a fetter which prohibited amendments which "would prejudice or impair the benefits accrued in respect of membership up to that time". The Court held that:

the creation of the money purchase section and the (compulsory) transfer of members to it was not prohibited by the fetter, but it did not permit the final salary link to be broken for their accrued final salary benefits. The Court determined that an underpin applied to member benefits, and so the conversion of their benefits should be recalculated and uplifted where a continuing final salary link would have meant that the members received a higher money purchase amount post-conversion in 1992, taking account of subsequent salary increases. If a top-up was payable it would include investment returns that it would have earned since 1992 and interest. Taking a pragmatic approach to the issue, the Judge held that this recalculation could happen for members whose benefits had not yet come into payment now so as to facilitate a proposed insurance buyout, even though this may be "a less generous approach".
because the change to benefits took place in 1992 in its entirety, pre-dating the 2006 age discrimination laws, there was no unlawful age discrimination. This was distinct from a situation where for example trustees might need to make a decision now about the payment of benefits, in which case they would be subject to the non-discrimination rule implied into all scheme rules.

The judgment in Avon Cosmetics Ltd v Dalriada Trustees Ltd, shows how, where a change to scheme rules is made which breaches a power of amendment, the Court can allow part of the amendment (ie the part that could have been validly made) to be "saved". The case involved an amendment to the accrual of scheme benefits from final salary to career average revalued earnings (CARE), with the final salary link for the accrued final salary benefits broken. The Judge confirmed that a restriction on the amendment power, which prevented prejudicial changes to benefits "accrued or secured" up to the date of the amendment, meant that the link to final salary for accrued final salary benefits could not be broken where members would otherwise have received higher benefits. An underpin should therefore apply in cases where a member's salary increases after the change were greater than in-service revaluation applied to their CARE benefits.

Two factors that were key to the Judge's findings were:

that it was possible to "separate" the valid and invalid exercise of the power. This was because it was specifically prejudicial changes that were prohibited by the amendment power fetter, and it was in practice possible to identify which members had suffered (or would suffer) prejudice. The change was valid to the extent that members' accrued benefits were not prejudicially affected
that even if the defective element of the change was corrected, the main purpose (and effect) of the amendments would have been within the overall objective intention of the trustees when they made the amendment. The purpose of the amendment was, broadly, the switch to CARE accrual. This was not altered by the retention of a final salary link for those who would be subjected to detriment without it.

Government issues consultation on options for DB pension scheme

The Government has just issued a consultation on three important areas concerning DB pension schemes – the extraction of surplus, the establishment of a permanent regulatory regime for superfunds and a public sector consolidator to be operated by the Pension Protection Fund.

More details to follow.