UPDATE 2: ECJ rules PPF compensation must amount to 50% of members' benefits

The Pension Protection Fund (PPF) must ensure it pays out at least 50% of individual entitlements to members whose funds were absorbed into the lifeboat fund, the European Court of Justice (ECJ) has ruled.

In a judgment handed down this morning (6 September), the ECJ said current compensation levels were not always enough, heeding the official opinion of one of the court's advocate-generals that PPF benefits were "unlawful".

While benefits for non-pensioners are capped at 90% of £39,006, with no indexation link granted to pre-1997 benefits, this is illegal if it amounts to less than half of the members' original entitlement, the ECJ ruled.

It can also affect members of schemes who had post-1997 benefits linked to the retail prices index (RPI); in the PPF, these benefits are uprated in line with the consumer prices index (CPI).

PPF member Grenville Hampshire, who brought the case, was forced to accept a 67% cut to his pension entitlement when his former employer, Turner & Newall, went insolvent in 2006, prompting an assessment period for the company's scheme. This saw the value of his pension fall from £76,302 to £19,189 per year.

The case was brought on the grounds that PPF was incompatible with Article 8 of the European Union's Insolvency Directive, but the PPF and UK government had argued this did not apply.

However, the court today said: "In the event of the insolvency of their employer [the directive] must be interpreted as meaning that every individual employee must receive old-age benefits corresponding to at least 50% of the value of his accrued entitlement under a supplementary occupational pension scheme in the event of his employer's insolvency."

The judgment will have a resounding impact on the level of compensation some PPF members will receive, and could also affect schemes that wound up outside of the lifeboat fund with PPF-level benefits.

A PPF spokesperson said the lifeboat had been in discussions with the government to consider what changes will be necessary for PPF and Financial Assistance Scheme (FAS) compensation.

"We will work to implement the judgment as quickly as possible but first need to consider the judgment further to understand what action we can take prior to legislative change and the conclusion of the UK court proceedings," they said.

"Members can be reassured that we will update them further as soon as we are able."

A Department for Work and Pensions (DWP) spokesperson said the government respected the decision, adding: "This is a complex matter and the government and the PPF are carefully examining the judgment to determine precisely how best to implement it."

'Good news for higher earners'

Herbert Smith Freehills professional support lawyer Tim Smith said some beneficiaries would clearly benefit more than others by the judgment.

"This judgment is clearly good news for higher earners whose schemes have entered the PPF and who have seen their benefits cut significantly. The compensation levels payable under the PPF will now need to be reviewed. This will have an impact on the PPF's funding levels and may feed into future levy payments."

The number of people who will be impacted by the judgment is expected to be small, increasing PPF liabilities by an estimated total of 1% or £215m based on an interpretation where the PPF would review the present value of benefits, rather than annual payments, PP understands.

Pinsent Masons partner Stephen Scholefield said he was not surprised by the judgment as it chimes with previous rulings by the ECJ on similar issues, and added that the most interesting aspect was that the PPF will have to apply the ruling on an ongoing basis.

"The issue for a lot of people is not so much the effect of the compensation cap, but the combination of the cap and the loss of pension increases on pre-1997 pensions," he said. "Both of those aspects together can drop you under 50% but sometimes the pension increases are as significant as the cap over time.

"It's clear the PPF is going to have to change the way it operates."

However, recent promises by the PPF about how it distributes its funding will now have to be reviewed, said Royal London director of policy Sir Steve Webb. The lifeboat fund's chief executive, Oliver Morley, recently indicated any surplus could be used to enhance members' benefits and reduce levy payments.

"Given that the PPF has spoken about what to do with its surplus funds, a priority must be given to address the position of people such as Mr. Hampshire who could find themselves receiving less than half their pension due to the limited nature of the PPF."

Trustees face mismatch

Scholefield called on the government to legislate clearly and quickly both to help the PPF understand how it should now calculate compensation, while also bringing clarification over a "mismatch" that will now be faced by trustees.

"The difficulty for most schemes now is there's a mismatch between what the PPF is required to do, which is comply with this 50% minimum rule, and what trustees are required to do if they are sufficiently well-funded to wind up outside the PPF.

"Trustees have to comply with section 73 of the Pensions Act 1995, which says that when you secure benefits outside the PPF, the first tranche must mirror PPF benefits, but it refers very specifically to them as set out in legislation. Trustees are now going to have this dilemma of do they follow the legislation that says apply the cap and the restricted increases, or are they going to somehow choose to override that on the basis that the legislation is now looking a bit defective?"

It is likely the Department for Work and Pensions (DWP) and PPF would now need to reconsider how schemes calculate their section 179 position - the valuation used to calculate the cost of insuring benefits at PPF-levels.

For these schemes, "there is a real issue as to precisely how do you secure these benefits," Scholefield added. "Schemes deserve a fairly clear statement from the government."

Smith agreed these problems could arise, noting: "The position of underfunded schemes that have narrowly missed out on PPF entry and also those schemes that have secured benefits outside the PPF on a PPF-plus basis will also need to be considered in light of this judgment."

Legislation urgent

The government also needs to answer the question as to whether the rule will be backdated, Scholefield added. Although, as Brexit nears, he said it would be unlikely for the government to hold out and not implement the legislation.

Pensions and Lifetime Savings Association head of defined benefit, local government pension schemes, and standards Joe Dabrowski agreed legislation needs to be brought forward urgently.

"The ruling today clarifies the minimum level of protection that pension savers can expect from the PPF and FAS following their employer's insolvency," he said. "It is important, nonetheless, that clarity is swiftly provided for affected individuals.

"If legislative changes are required to enable the PPF to provide the correct levels of compensation and assistance, then we'd like to see these brought forward as soon as possible by the DWP."

The matter was referred from the Court of Appeal and will now be remitted back to the court to end UK proceedings.

Although the case has not officially come to an end, the next steps are now procedural, with the PPF required to implement the ruling as soon as possible.