If the (compensation) cap doesn’t fit…

Following a referral by the Court of Appeal to the European Court of Justice (ECJ), the Advocate General (the AG) has given her opinion on the application of Article 8 of the EU’s Insolvency Directive (the Directive) in the context of the Pension Protection Fund (PPF) compensation cap (the Cap).

The PPF exists as a lifeboat scheme to pay compensation to the members of defined benefit occupational pension schemes in certain circumstances (broadly, in the event of the sponsoring employer’s insolvency, where the assets of the scheme are less than a certain level). When a scheme is accepted into the PPF, the compensation payable to members is calculated in accordance with the relevant legislation. The Cap is applied to the pension payable to members who are under normal pension age at the start of the PPF assessment period, and to the benefits payable to individuals who are active or deferred members and under the scheme’s normal pension age at the date on which the scheme’s sponsoring employer became insolvent. The Cap is currently £39,006.18 at age 65, which is reduced to £35,105.56 once the 90% has been applied.

The referral to the ECJ was made following an appeal by a scheme member, Mr Hampshire[1], against the High Court’s decision that the application of the Cap did not contravene EU law.

Article 8 of the Directive requires each EU member state to take “necessary measures” to protect the pension rights of employees and former employees in cases where their employer has become insolvent. In a previous blog post we wrote about Mr Hampshire’s case; he claimed that the Cap contravened EU law because his annual benefits payable by the PPF were reduced to less than 50% of the benefits payable to him under the rules of his scheme, had the scheme been able to pay his benefits in full and not gone into the PPF.

Why was the referral made?

Mr Hampshire’s claim was rejected by the PPF, the PPF Ombudsman and the High Court. The PPF asserted that the Cap only applies to around 0.2% of members receiving compensation, and therefore looking at the compensation system as a whole, the implementation of the Cap did not contravene the requirement for member states to take “necessary measures”, as described above. Mr Hampshire took his case to the Court of Appeal. The questions referred by the Court of Appeal to the ECJ were whether:

• Article 8 requires member states to ensure that every individual employee receives at least 50% of the value of their accrued rights in the event of the employer’s insolvency;
• It is sufficient under Article 8 for a member state to have a system where employees usually receive more than 50% of the value of their accrued rights but some individuals receive less than 50%;
• Article 8 is directly effective in the circumstances of the present case.

Decision

In the AG’s opinion (which is given prior to the ECJ’s ruling), Article 8 of the Directive should be interpreted so that every individual receives at least 50% of their accrued benefits. The AG reached this conclusion following consideration of the ECJ’s specific use of the words “in certain cases” in a previous decision[2] when referring to the reduction in the level of benefits which fell to 20% and 49% for two individuals. In that case, the Court ruled that such levels of benefits could not be considered to protect the interests of employees within the meaning of Article 8 of the Directive. The AG also noted that the aim of the Directive was to ensure a minimum degree of protection for all employees, which could only be achieved if the minimum standard applied to each individual employee.

The AG also went on to consider whether a lower level of compensation could be justified and determined that it could not. The UK argued that the imposition of the Cap serves as a means of tackling moral hazard. The AG rejected this argument citing that senior executives who had already reached their scheme’s normal pension age were not covered by the Cap, even if there was a possibility that they had been involved in high-risk business decisions that contributed to the employer’s insolvency.

Finally, the AG determined that Article 8 of the Directive has direct effect and could be relied on by individuals against a body such as the PPF. The AG commented that Article 8 of the Directive contains an obligation to member states which is “unconditional and sufficiently precise”.

What’s next?

The ECJ will give its response to the questions. Although the ECJ is not bound by the AG’s opinion, it seldom departs from it. Assuming that the ECJ agrees with the AG’s opinion, the UK Government will need to amend the legislation to ensure that when a scheme enters the PPF, every affected individual receives at least 50% of their accrued benefits.