Pensions Essentials - February 2025

Between 6 April 1997 and 6 April 2016, schemes could contract members out of the second tier of the state pension on a “reference scheme test” basis. The actuary needed to certify that a scheme continued to meet this test every three years and, generally, when amendments were made, provide confirmation that it was still satisfied. In July 2024, the Court of Appeal confirmed that where the required confirmation was not obtained in relation to pre 6 April 2013 amendments, amendments would be void. 

This has resulted in schemes doing reviews of historic amendments and it is clear that actuarial confirmations cannot now be found in all cases. This is causing considerable uncertainty and as reported in Pensions Essentials last month, the industry continues to ask the government for regulations to deal with the issue. There is also a further case being heard by the court which may consider evidential issues in relation to missing confirmations.

In the meantime, if an amendment is found to be void, this could potentially increase scheme liabilities and the potential cost to sponsors. This means that auditors of both scheme and sponsor financial statements are having to consider the impact (if any) of the decision.

The Institute of Chartered Accounting for England and Wales has issued guidance for auditors on the case. It envisages that trustees will have adopted one of three approaches:

• Wait and see: This may be appropriate where, for example, there is no reason to think that historic deeds lacked the required confirmations and/or mounting a full investigation would be costly. The guidance points out that this approach does not mean that trustees do not need to do anything.
• Information gathering: Trustees could obtain a fuller picture about whether there is a potential issue. This approach is scalable depending on the circumstances of the scheme and may, for example, involve identifying which deeds amended reference scheme test benefits as they are the only ones for which confirmation would be required. 
• Detailed analysis: Detailed consideration would be given as to whether the scheme is paying the correct benefits and what scheme liabilities should be. There is an acknowledgement that trustees may “conclude that it is not a prudent use of scheme resources to perform a detailed assessment while so many uncertainties remain” and that most trustees are unlikely to go down this route for the moment.

Whatever the approach, sponsors need to consider how to present the potential impact of the case in their financial statements. The guidance suggests three potential accounting treatments:

• Not recognise any amounts or make any disclosure – This might be appropriate where a scheme was never contracted-out on a reference scheme test basis, investigations have shown there is no problem or the size of the scheme is immaterial to the size of sponsor. It may be challenged by auditors and should be discussed with them in advance. 
• Disclose potential implications of the case in the pension note but not recognise any amounts – As most trustees will not have completed a detailed assessment, it is unlikely to be clear how DB liabilities might change and whether they need to be reassessed. In these circumstances, it might be appropriate to make a disclosure around the additional uncertainty over the measurement of the DB obligation which is specific to the circumstances of the scheme and sponsor.
• Remeasure the DB obligation and recognise a change - It is unlikely that enough information will be available to quantify any impact on the DB obligation while investigations are ongoing as this would require detailed legal, actuarial and data analysis. If this has been completed, sponsors will need to consider whether and how to recognise any change within their financial statements. Consideration would then need to be given as to the correct accounting treatment and a prior year adjustment may need to be made, as the scheme liabilities would have been historically misstated.

Sponsor auditors will need to make judgements about the approach that needs to be taken depending on the specific circumstances of the scheme. Early communications with sponsors will be important who, in turn, should be in touch with trustees. The guidance confirms that where it is expected that schemes will be affected by Virgin Media, it may not yet be possible to tell how material any impact could be. 

Three potential options are identified for auditor’s reports:

• No impact - This is likely to apply in most scenarios. It would be the case where, for example, scheme liabilities are immaterial or Virgin Media may apply and trustees have not completed their investigations but the auditor concludes that the potential effect of the ruling has been appropriately reflected. 
  
  If the auditor considers that the financial statements do not adequately reflect the issues raised by Virgin Media, the first step is to discuss their concerns. The trustees or sponsor may be able to provide additional justification to support their choices or may conclude that further action, recognition or disclosure is appropriate and adjust the financial statements accordingly.
• Wording in report to draw attention to issue - An Emphasis of Matter paragraph can be included in an audit report to draw attention to a matter that, in the auditor’s judgement, is of such importance that it is fundamental to users’ understanding of the financial statements. This would only be expected to be necessary in limited circumstances where the pension scheme liability is highly significant and, for example, the scheme has made significant amendments that could create a material future issue, but the auditor doesn’t feel that the disclosure in the pension note is sufficiently prominent for users to understand the importance of the issue.
• Issuing a qualified opinion due to a lack of available information - A modified opinion is issued if the auditor concludes that the financial statements are not free from material misstatement or is unable to obtain sufficient evidence to confirm this. A qualification might be likely where, for example, information suggests a potential material impact on the scheme but no legal advice has been sought. Alternatively, there may be cases where insufficient information has been provided for the auditor to meaningfully evaluate the disclosures in the financial statements. However, issuing a qualified audit report may not be proportionate unless it seems probable that a scheme will have additional material liabilities and given current uncertainties, this is a high bar.

This press release accompanying the determination says that it “provides important lessons for pension schemes about the importance of properly documenting benefits promised on transfers in and on scheme mergers”.

Facts: H joined the scheme in 1981 and became entitled to executive benefits in 1989. The executive booklet said that members would receive increases of RPI capped at 5%, although it contained provisions saying that the booklet did not override the scheme rules and the increases were not reflected in the rules. Under the rules, increases were paid “at such percentage rate per annum compound as may be fixed from time to time by [the Trustees at the direction of] the Principal Employer”. 

In 1996, H’s employment was transferred as a result of a reorganisation. A bulk transfer was proposed to the new employer’s scheme. H was the only executive transferring and was told that the new scheme would mirror his benefits in the transferring scheme. H left service in 1998 and retired in 2014. 

In 2015, the trustees received advice that the increases generally being paid to members were incorrect and did not reflect the rules and pensions would be frozen until they had reached the correct level.

H complained that he had a right to increases of RPI capped at 5% in the original scheme and this transferred to the new scheme. The employer argued that the rules had never reflected this and H had no contractual entitlement to it.

Determination: The Ombudsman determined that:

• There was a contract between H and the employer to provide the promised mirror image benefits in the receiving scheme. Even though this was never reflected in the scheme rules, all the elements of a contract – offer, acceptance, consideration and intention to create a binding agreement were present.
• The employer's commitment to procure mirror benefits in the new scheme was a continuing contractual obligation and was only breached when it finally confirmed in 2017 that it would not pay the promised increases. As H complained to the Ombudsman within 3 years of that confirmation, there was no limitation issue. In addition, as the appropriate remedy was for the employer to “specifically perform” the contract and pay the promised increases (as opposed to the payment of damages for breach of contract), limitation periods were not relevant as they did not apply to specific performance. 
• The employer had breached the implied duty of good faith not to destroy or seriously damage the relationship of trust and confidence between an employer and a scheme member.
• The employer and H had acted on an agreed assumption that H would receive specific benefits in the new scheme and that this would be documented in due course. Both parties had conducted their relationship on the basis of this continued assumption so the employer was “estopped” from denying the assumption was correct.
• The transfer-in power in the new scheme gave the trustee discretion to determine the basis of benefits to be provided so it could not argue that it had no power under the scheme rules to provide the agreed benefits. 
• The transferring scheme had never provided for RPI/5 increases and all the announcements H received were said to be subject to the terms of the rules. The rules actually provided for increases as directed by the employer. The Ombudsman concluded that based on the evidence, the employer had directed in accordance with the rules that H would be paid increases at RPI capped at 5%.

The actual award made by the Ombudsman was complicated but in broad terms, he directed that H’s executive pension prior to 1 April 2025 should be increased as promised by RPI capped at 5%. However, from 1 April 2025, H's pension increases should reflect the rules of the transferring scheme and be at a rate determined by the trustee, at the employer's direction. The Ombudsman also directed the employer to amend the scheme rules or augment H's benefits to give effect to the promised mirror image benefits and pay H £1,000 for the serious distress and inconvenience sustained.

Relevance: This is a cautionary tale about the need to ensure that benefits payable following mergers and bulk transfers are properly documented. What may be clear to everyone at the point of transfer is easily lost in the mists of time. 

As H was the only member in his category, he had communications directed solely at him and direct conversations about his benefits. It could be significantly more difficult for other members to demonstrate a similar level of commitment and clear intent to provide a particular level of benefits.

The Disclosure Regulations require trustees to prepare an annual report within 7 months of the end of each scheme year One of the things it must contain is a description of “the voting behaviour by, or on behalf of, trustees (including the most significant votes cast by trustees or on their behalf) during the year” and whether the services of a proxy voter have been used. This information also needs to be included on a publicly available website, free of charge.

In addition, where trustees are required to prepare a statement of investment principles (SIP), it must set out their policy in relation to “the exercise of the rights (including voting rights) attaching to the investments; and… undertaking engagement activities in respect of the investments (including the methods by which, and the circumstances under which, trustees would monitor and engage with relevant persons about relevant matters).”

DWP issued guidance in 2018 on how schemes should report their stewardship activities, both in the SIP and online. The guidance says that “DWP expects trustees to either set their own voting policy or if they have not set their own policy, acknowledge responsibility for the voting policies that asset managers implement on their behalf. Ultimately, trustees are encouraged to take ownership of the scheme’s stewardship policies. This means it is not enough for trustees to simply report that they have delegated stewardship to their asset managers”. It accepts that there may be more constraints where trustees are invested in pooled funds but highlights ways in which trustees can still be actively engaged. 

In relation to the voting information that should be placed on a website in the implementation statement, the guidance suggests that a slightly surprising amount of information is required. It says that as a minimum, trustees should include the following in relation to the most significant votes:

• Which stewardship priority the vote was linked to.
• The company’s name (unless there are particular sensitivities around disclosing this) and date of the vote(s).
• Approximate size of the scheme’s/ mandate’s holding as at the date of the vote.
• A summary of the resolution.
• How the trustee, asset manager, or service provider voted.
• If the vote was against management, whether this was communicated ahead of the vote.
• Rationale for the voting decision.
• Outcome of the vote.
• Whether the trustee / asset manager / service provider intends to escalate stewardship efforts.

The PLSA issues stewardship and voting guidelines each year which can help to formulate stewardship policies and an approach to voting. 

The 2025 guidelines have just been issued and they:

• Provide an overview of recent political and economic developments that have an impact on stewardship; 
• Sustainable finance developments, including the new Government’s focus on this area; 
• Social factor developments, including the DWP Taskforce on Social Factors; 
• Workforce developments, including issues such as maternity and paternity pay and leave policies, and ethnicity and disability pay reporting; 
• Guidance as to what “good” looks like in a variety of corporate scenarios; and
• Guidelines on how to vote in different scenarios.