The Court of Appeal upholds decision to disapply the PPF compensation cap

The Court of Appeal has approved the Pension Protection Fund’s proposals for ensuring compensation is at least 50% of a member’s pension, but upholds the High Court’s decision to disapply the PPF compensation cap.

Background

Where the sponsoring employer of a defined benefit pension scheme suffers insolvency and the scheme has insufficient funds, the PPF becomes responsible for paying compensation to the members. The level of compensation payable to those who have not reached their normal pension age ("NPA") is subject to a compensation cap.

In 2018, the CJEU held in Hampshire v Board of the PPF that Article 8 of Directive 2008/94/EC (the "Insolvency Directive") requires Member States to guarantee compensation of at least 50% of each member's accrued pension entitlement in the event of the employer's insolvency.

In response to this ruling, the PPF implemented a one-off actuarial valuation of the benefits the member would have been entitled to under their scheme and a valuation of the compensation the PPF would pay in respect of the member over time. If the value of the PPF compensation is less than the projected value of the benefits provided under the scheme rules, then an uplift is applied to bridge the gap.

High Court decision

In 2020, Mr Hughes and others contended that the imposition of the compensation cap under the Pensions Act 2004 on those who have not yet reached NPA was age discriminatory. They also argued that the methodology adopted by the PPF to ensure that pensioners and survivors receive at least 50% of the value of their respective scheme benefits was incompatible with the requirements of the Insolvency Directive.

The High Court handed down its judgement in June 2020 and held as follows:

• The PPF's approach to the Hampshire Uplift did not comply with the Insolvency Directive as the one-off calculation made it possible for the amount paid as PPF compensation to be less than 50% of the member's entitlement under the scheme's rules if actual experience did not match the actuarial assumptions used.
• The PPF's methodology for calculating the compensation payable in respect of contingent beneficiaries was unlawful. The PPF's approach calculated the annual rate of compensation for survivors as half the annual rate of compensation to which the member would have been entitled if they had not died. The High Court held that the rate of compensation should instead be calculated as half the value of the benefits that the survivors themselves were entitled to under the scheme. This was intended to avoid scenarios where, even if the survivor was entitled to 2/3 of the member's benefits under the scheme's rules, they would only receive compensation amounting to half the compensation paid to the member under the PPF's approach.
• The provisions in legislation which capped PPF compensation payable to members who have not reached NPA amounted to unlawful age discrimination.

PPF's appeal: 50% methodology

The PPF's appeal centred on the interpretation of the Insolvency Directive and the compatibility of the methodology used for the Hampshire Uplift with the provisions of the Insolvency Directive.

The Court of Appeal found in the PPF's favour on the basis that the relevant EU caselaw has consistently found the Insolvency Directive to be "very general, open-textured and broad", and that calculating a projected value is sufficient to meet the obligation imposed by the Insolvency Directive.

In respect of the rights of survivors, the Court of Appeal held that the Insolvency Directive protects a bundle of rights which belonged to the employee and did not require each component of that bundle of rights to be separately protected. As such, there was no separate testing for survivor benefits, which could also create a risk of double counting.

Secretary of State's appeal: age discrimination

The Secretary of State appealed the High Court's decision that the compensation cap was unjustified age discrimination. It argued that the application of the compensation cap was appropriate and necessary in the pursuit of legitimate aims because:

• the cap incentivised the proper funding of schemes and discouraged employers from underfunding schemes on the basis that the PPF will pay out full compensation in respect of all members; and
• the cap was necessary and appropriate to reduce the overall cost of compensation to manageable levels.

The Court of Appeal dismissed the Secretary of State's appeal and found that the cap was not appropriate and necessary. In particular, it noted the disproportionate impact the compensation cap had on a small group of workers.

Commentary

The impact of the compensation cap has been severe in certain cases, notably for members with high pension entitlements or those who are entitled to retire early. While the disapplication of the compensation cap will be welcomed by affected members, the funding impact to the PPF is unlikely to be significant, with only ~0.5% of cases currently subject to the compensation cap.

The more significant impact of the decision is the validation of the one-off actuarial comparison, enabling both the PPF and schemes providing benefits by reference to PPF compensation to carry out a one-off assessment without periodic checks and dual track data.

This article was co-authored by trainee solicitor Rahim Velji.