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Court of Appeal confirms PPF compensation cap is unlawful

  • United Kingdom
  • Pensions

02-08-2021

Summary

In the latest chapter in a long-running dispute over the validity of the PPF compensation cap, the Court of Appeal (“CA”) has held in a unanimous judgment that:

  • the compensation cap (which is set at £41,461 for 2021/2022, and applies - broadly -to those below normal retirement age when their scheme enters the PPF) is unlawful, as it is direct age discrimination which cannot be objectively justified; but
  • the way the PPF is intending to compensate members so that they receive at least 50% of their accrued pension benefits (as required by EU case law) is lawful.

Background – 50% compensation requirement and PPF proposed approach

As a very brief reminder, the PPF provides compensation (a) at 100% to members who are receiving pensions and are over the scheme’s normal retirement age at date of PPF entry / receiving an ill health pension, and (b) at 90% of accrued benefits for all other members.  That 90% is then applied to a capped amount – currently £41,461 for 2021/2022.  The imposition of that monetary cap can, therefore, materially reduce some members’ pension benefits. 

As explained in our earlier briefing on the High Court decision, the current litigation stems from the decision of the CJEU in Hampshire v PPF in September 2018.  That case confirmed that every individual member of a scheme which is eligible for the PPF must receive compensation equal to at least 50% of the value of their accrued pension entitlement.

Following the Hampshire decision, the PPF proposed to adopt an approach under which it would conduct a one-off actuarial valuation of the pension benefits payable to each member under their original scheme, rather than considering each year whether the amount of compensation actually being paid was equal to at least 50% of the pension benefits which would otherwise have been paid in that year under the scheme rules.  

The PPF would then compare that actuarial valuation with a valuation of the amount of compensation the PPF would pay that member over time and, if necessary, it would apply an uplift to the member’s PPF compensation to meet the 50% minimum threshold.

The High Court decision – a recap

The High Court had considered challenges brought by Mr Hampshire and other members caught by the compensation cap, such as Mr Hughes. They challenged:

  • the way in which the PPF was proposing to calculate the 50% compensation by a one-off test; and
  • the lawfulness of the monetary cap that was applied. 

The challenge to the validity of the cap was essentially brought on grounds that the age discriminatory nature of the compensation cap was contrary to EU principles of equal treatment.

In his July 2020 judgment, the High Court judge agreed with the claimants on the majority of the points raised and held that the PPF could not simply rely on a one-off actuarial value test, because such tests include assumptions which may not be borne out in practice, particularly if the member lives longer than anticipated. The judge also considered that the 50% test had to be applied separately to any survivors’ benefits payable.

On the age discrimination arguments, the judge was of the view that the 10% reduction in benefits faced by all members who were below normal pension age at the assessment date could be justified, pointing to the legitimate aims of deterring “moral hazard” – the risk that senior company decision makers would rely on the presence of the PPF and so would take unnecessary risks with the funding of their DB schemes.  The reduction was also considered justifiable to keep the costs of the PPF levy manageable for levy payers.  However, the severe impact on the small cohort of members who were subject to the cap could not be justified: though the aims were legitimate, the cap was not a necessary and proportionate means of fulfilling those aims.

The Court of Appeal decision - PPF approach to calculating 50% compensation

The CA confirmed that the proposed approach of a one-off actuarial value assessment is lawful, with no need for further checks to be carried out throughout the member’s lifetime.  In more detail:

  • The CA considered that the language both of the EU Insolvency Directive and of the key CJEU decisions (including Hampshire) was sufficiently broad to permit the use of a single actuarial assessment of the future value of the member’s pension income stream, and that there was nothing to suggest that it was necessary to revisit that assessment or the actuarial assumptions underpinning it at any point thereafter. 
  • The CA emphasised, however, that the PPF should not assume that its calculation approach was therefore wholly immune from further challenge:

We express no view as to how finely tuned the actuarial assumptions used in the PPF calculation must be to reality, or how broad or narrow might be any margin of judgment or discretion the PPF has in adopting such assumptions.”

  • On the question of survivors’ benefits, the CA again departed from the reasoning of Lewis J, holding that the 50% value requirement confirmed by the CJEU in Hampshire applied to the entirety of the member’s rights (including contingent survivors’ benefits): it did not have to be applied individually to each element of the member’s rights.

The Court of Appeal decision – the compensation cap

The CA squarely agreed with the High Court’s decision that the PPF compensation cap (which is clearly direct age discrimination) was not objectively justified as being a proportionate means of achieving a legitimate aim. In more detail:

  • The CA confirmed that a distinction could be drawn between the 90% limit on benefits for members below their normal pension age, which the CA held to be lawful, and the application of the cap: the 90% limit was still consistent with the overriding aim of protecting member benefits and was also an appropriate and necessary means of achieving the legitimate policy aims established by the Secretary of State for Work and Pensions.  In contrast, the cap “produces, for a small number of employees further very significant reductions in protection …. They do not obviously or materially … further either of the legitimate aims.
  • The CA also held that the judge was correct to conclude that the Secretary of State had to justify the original form of the PPF compensation cap as enacted in 2005, rather than just the current version of the cap (which includes the long-service provisions introduced in 2017).  As well as the CJEU decision in Hampshire, the very fact that Parliament had decided that the 2017 modifications were required undermined the argument that the cap as originally enacted was justifiable.  Also, because the 2017 changes were prospective only, and limitation would prevent many members from recovering substantial past losses arising from failure to respect the 50% minimum, it was not adequate to focus solely on the current PPF provisions.

Comment

Understandably, the CA decision has been welcomed by the PPF, as it allows the PPF to continue with its current approach to adjusting compensation in accordance with Hampshire.

It remains to be seen whether any members will want to bring any challenge to the assumptions adopted by the PPF, but given that the PPF generally conducts public consultations on its various assumptions and methodology, it seems fairly unlikely that any such attempt would be successful.

The Secretary of State has confirmed there will be no appeal against the CA decision regarding the unlawful nature of the cap.  It also looks unlikely that further arguments will be raised as to why the courts should depart from established EU law in relation to this issue. 

This suggests that the current litigation is now at an end, unless the claimants seek leave to appeal on the question of the PPF’s approach to the calculation of Hampshire compensation.

The main residual area of uncertainty is what the PPF will do in relation to members who have been subject to the compensation cap: in particular, how far back in time the PPF needs to go to correct this (for example, is a six-year look-back sufficient?).  We understand that the parties are intending to consider this further.  It could clearly have a material impact on some of those affected: e.g. Mr Hampshire’s scheme remains in an assessment period over 15 years after the sponsoring employer became insolvent, and many of the other schemes involved in the Hughes litigation similarly first entered assessment over six years before the High Court ruling in July 2020.