The Court of Appeal (CA) has allowed an appeal from an employer on the interpretation of a pension scheme’s pension increase provisions. The interpretation preferred by the CA is expected to result in significantly lower liabilities for the employer.
The facts of the case
The power of amendment in the FDR Limited Pension Scheme (the Scheme) contained a proviso, preventing amendments to the Scheme which would prejudice accrued benefits. Until 1991, the Scheme’s pension increase rule provided that pensions in payment would be increased each year by 3% compound. This rule was amended in 1991 to provide that pensions in payment would be increased each year by the lesser of 5% and inflation. No differentiation was made in the new wording between pension accrued prior to the 1991 amendment and pension accrued after the amendment.
Following the making of the amendment, the Scheme was administered on the basis that pension relating to all service (both before and after the amendment) would be increased by the lesser of 5% and inflation. However, it subsequently became clear that this interpretation was in breach of the proviso to the amendment power, because the increase applied in respect of pre-1991 accrual had the potential to be lower than 3%, if inflation fell below that level.
The trustees and the employer agreed that an underpin of 3% should apply to pension accrued pre-1991, in accordance with the rule which applied at that time. However, the parties disagreed as to how the underpin should apply. The trustees made an application to Court for directions.
What did the judge decide?
In the High Court, the judge considered three methods of applying the underpin. As one was the trustees’ fallback position, should their first method fail to convince, we will only refer to two here. The trustees contended that each year, the pre-1991 element of a member’s pension should be increased by an amount between 3% compound and 5% (calculated as the lower of 5% and inflation, with a minimum of 3% compound). The employer’s position was that in respect of the pre-1991 element, a member’s starting pension should be increased by 3% compound year on year (up to and including the latest increase) and compared with the figure reached if the member’s starting pension was increased by the lesser of 5% and inflation (compound) year on year. The higher of the two figures would be the pension paid to the member.
The employer argued that the two increase provisions (pre- and post-1991) should not interact with each other but be calculated separately, resulting in a cumulative underpin.
The judge agreed with the trustees, preferring a blend of the pre- and post-1991 rules, as she felt that their approach represented a reasonable and practical approach, which was supported by previous cases. Such an approach would not require complex calculations to be carried out, but simply a comparison of the previous year’s pension increased by the percentages set out in each of the pre-1991 and post-1991 rule. The employer appealed to the Court of Appeal.
What happened on appeal?
We commented in a post on the High Court decision [http://talkingpensionsblog.gateleyplc.com/2015/10/28/an-increase-in-member-success/] that the practical approach taken by the judge meant that trustees could avoid taking an overly technical approach.
However, the Court of Appeal did not agree with the judge’s decision. In his judgment, the leading judge set the scene by explaining that the difference between the two interpretations was that the trustees’ method required the increase in pension to be calculated annually by applying the increase to the pension paid in the previous year (with an underpin of 3% compound), whereas the employer’s method required an annual calculation made in respect of the whole period over which the pension had been in payment, to see which of the pre-1991 and post-1991 rules would give the higher pension.
The judge did not agree that it was relevant to look at the question of administrative simplicity or difficulty in applying the pension increase rule. He agreed with the employer’s suggestion that the purpose of the proviso to the amendment power was to ensure that a member would receive a pension which, in any given year, was not less than the pension she would have received, if that pension had been increased by 3% compound since the date when it began to be paid. So the pension, increased under the post-1991 rule, had to be compared with what it would have been, had it been increased year on year under the pre-1991 rule. The Court agreed with the employer’s interpretation. Lord Justice Lewison, who gave the lead judgement, suggested that this method is not complicated, but involves the use of “an algebraic formula, which is not conceptually difficult to understand, and uses mathematical techniques which have been known for centuries”.
What are the implications of the case?
While the Court of Appeal’s decision represents a retreat from the more practical approach taken by the High Court, it is difficult to argue with the interpretation of the effect of the proviso to the amendment power on the amendment made to the pension increase rule in 1991. Members of the Scheme will now be in no worse a position than they would have been, had the pre-1991 rule not been amended (albeit they could potentially be in an improved position).
The interpretation of pension increase rules will depend on the wording contained in a particular scheme’s governing documents but subject to any further appeals of this decision, the judgment provides clarity on the application of an underpin, where an amendment power is fettered to prevent amendments which could prejudice accrued benefits. Employers will welcome the decision as it could result in a lower level of liability rather than historic errors resulting in members being entitled to benefits that neither formula would have produced on its own. Schemes where amendments to pension increases have been found to have been effective from a later date than previously assumed may wish to look at how any underpin is being applied in practice.
For further information, please contact:
Michael Collins, partner, Pensions
T: 0121 234 0236
 FDR Limited v Dutton & Ors 29 March 2017