Employers and changing benefit rules
Two Court of Appeal judgments have allowed schemes to introduce a pensionable pay cap. James Phillips explains the reasons why and what to be aware of.
For defined benefit (DB) schemes still open to accrual, the ability to impose a cap on increases in pensionable pay can be a way of stemming a growth in liabilities.
Yet the route to doing this does require member consent, in most cases, and therefore trustees will need to ensure their communications are accurate and not misleading.
The two cases demonstrate the importance of following due process when making such decisions, but also strengthen an employer's ability to make changes to benefits.
The cases tackled two very different processes whereby BBC and IBM had sought to impose these caps on pensionable pay increases.
The BBC had hoped to introduce a 1% cap to limit the amount it had to pay into the scheme which, by its estimates, without intervention, would see its annual contributions rise from 3.5% of the licence fee settlement to 10%.
Yet, Mr Bradbury, a clarinettist in the philharmonic orchestra, argued the change was in breach of the BBC's duties of trust and confidence - particularly stating he had contributed to the scheme in good faith believing his pensionable salary was his basic salary, under the scheme's rules.
However, in the recent Court of Appeal judgment, Bradbury's arguments were rejected, with the court noting there was no such breach, and that the broadcaster was able to impose a cap in order to remain commercially viable. This cemented the idea that keeping pension costs under control was an important factor to be taken into account, among others, when seeking to make changes.
Similarly, in the IBM case the Court of Appeal again sided with the employer, allowing it to make a series of changes it had introduced to limit the deterioration of the scheme and its own commercial prospects.
In this case, a number of members took issue with the changes the company sought to impose in 2011, including closing the scheme to future accrual and making future pay increases non-pensionable. In particular, they relied on past communications from the company that said earlier changes made in 2006 were"long-term".
The High Court agreed with the members in 2015, stating they had"reasonable expectations" not to expect any changes and therefore that the company had breached its duty of good faith.
However, earlier this month the Court of Appeal overturned this, arguing that it was appropriate for IBM to implement these changes, despite these earlier statements.
The two cases highlight the case-by-case nature that must be recognised when schemes wish to make changes, yet with two employer-friendly judgments they will provide some useful lessons for the industry.
For example, PwC legal director Marcus Fink argues, they show that the court recognises the need for businesses to be able to plan for the future when new economic situations arise.
"In a commercial context, it has to be right that businesses can control their remuneration policy - and pensions is a major part of that - and it is helpful that post the Court of Appeal judgments employers can actually plan around pensions and factor that into the wider business framework," he states.
"Previously, it was felt that they couldn't. They may be in a good position now financially, but that's not to say that 10 years down the line, if they don't address risk issues now and their economic climate changes or the market changes, then it's too late. They have to plan 10 years in advance; that's just good business sense."
Nevertheless, the concept of reasonable expectations did play a major part in both judgments, particularly in the IBM case where the High Court had made a somewhat special note of these.
Although the Court of Appeal did agree reasonable expectations had been formed, it disputed the level to which the High Court had elevated their importance in an employer's decision-making process.
In these cases, both employers were required to have met the 'rationality test', whereby they needed to only take into account relevant factors, and ignore irrelevant factors, in reaching their decisions.
Each factor can be given different weighting, depending on the circumstances, but in the IBM judgment the Court of Appeal ruled the High Court had granted too much importance to these reasonable expectations.
Sackers associate director James Bingham says the courts will not necessarily overlook these expectations but that other factors may play a larger role.
"While member expectations are not irrelevant, they are no more relevant than any of the other factors that have to be considered by an employer deciding whether the steps they are going to take are rational or irrational in a legal sense," he argues.
"From the point of view of members, what they've been told falls short of a promise and is not irrelevant, but it won't accord them any greater protection than any other statement would. Employers are not bound to give that any more weight than any other factors that they may be considering. Member expectations don't constrain the way in which the employer can make changes to its pension arrangements."
At the heart of the forming of these expectations, and indeed the weight they should be given, is perhaps the exact wording used by employers in their communications. For example, documentation and statements will be scrutinised to identify whether a clear promise has been made.
Fink explains:"There are so many other factors that would come into play, and obviously the strength of the communications is one. If it's a cast-iron guarantee then that consideration assumes extreme prominence, but if it is just conversations or clarifications that are meant to be helpful rather than evergreen contractual commitments, then that falls down when considering everything.
"Now, communications are still of prominent importance but not insurmountable."
Of course, not all expectations arise from scheme communications, however. It is important for employers to understand the contractual obligations they are under, including by truly understanding the wording of each employee's contract of employment.
Doyle Clayton head of pensions Andrew Campbell states the case may have resulted in a different outcome if contracts had outlined the rules on pensionable pay in this way.
"Where the IBM decision is relevant, every company has its own terms of employment," he states."The position may have been different, for example, if members were able to point to something in their terms of employment that meant they were automatically entitled to a pay increase and that such pay increase was made on the basis it was fully pensionable."
The judgments bring some distinct comfort to employers hoping to make changes to their schemes to stymie the growth in liabilities.
Burges Salmon partner Richard Pettit says the ruling is sensible and enables employers to make changes to ensure their businesses do not come under undue financial pressure.
"If you step back from it, it seems strange that employers could have their hands tied," he says."They almost risk being tapped up for doing things in an organised fashion. These cases were much needed."
The High Court ruling in IBM had arguably set a high bar for companies seeking to make changes, whereby they could only go against past communications and seek to amend their scheme in extreme circumstances.
For example, they needed to show why there was no alternative way of making cost savings to implementing changes.
Now that the Court of Appeal has given this judgment, PwC's Fink reckons these employers will feel more relaxed and that there will be a number of movements among DB schemes in the near future.
"Many large organisations shied away from looking at and changing their DB pensions purely because they felt they didn't have that killer ‘we have to make this change and this is the only way we can save costs' argument," he states.
"Now we have this appeal court judgment, they will certainly be looking at whether changes are appropriate given the climate that they mind themselves in."
Yet, for members, the judgments will be disheartening, and seemingly present a view that they should not be able to form any overwhelming expectation from communications, and that bringing any case similar to this may be unlikely to succeed.
Sackers' Bingham states these members should look, at the least, to their trustees to represent their interests and ensure an employer isn't overlooking their obligations.
"From the member perspective, it may make people slightly twitchy about whether companies will try to force changes through, but I would have less concern on that front because IBM was an extreme case and there are still hurdles that have to be overcome," he says.
"Trustees, by their very nature, will provide a check and balance in that process."
Both Court of Appeal judgments had warranted some degree of nervousness from sponsoring employers of DB schemes, who will now be breathing a sigh of relief as they have appeared to be given more leniency to go ahead with structural changes to benefits.
Nevertheless, they should remain cautious about their approach to communications and will need to ensure they fully understand the contractual commitments they have already made to their employees.
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