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Professional Pensions Ruling Bolsters Employers

Sebastian Cheek examines the fallout from last week’s High Court ruling to uphold the Prudential Assurance Company’s decision to cap discretionary increases for its scheme members.  Last week’s High Court ruling in favour of the Prudential Assurance Company’s decision to cap discretionary increases for pensioner members of its scheme is welcome news for employers in a similar situation, lawyers say.

1.  Capping discretionary pensions - is the company acting in good faith?

Pensioner members of the Prudential Staff Pension Scheme were given a bitter pill to swallow when the High Court ruled it was acceptable for their former employer, one of this country’s biggest insurers, to have capped their discretionary pension increases at 2.5% in 2005, rather than in line with the Retail Prices Index. In the case, brought by the scheme trustees, members argued RPI was the measure Prudential had used for discretionary increases for decades prior to the decision to cap them in 2005 and by introducing the measure almost overnight the company was not acting in good faith.

However, summing up the judgment Mr Justice Newey said, while he can well understand that DB members will have been disappointed by the 2005 decision and feel themselves to have been treated unfairly by Prudential, in his opinion the company had not breached its obligation of good faith owing to a lack of “irrational or perverse” action. Charles Russell associate Michael Jones said the ruling in this case was very welcome. “You can’t help feeling there is a bit of chancing your arm from the membership,” he said. “If the decision had gone the other way it sends out a message to companies that you should never exercise a discretion because you could be stuck with it – that should not logically be the message to send out at all.” Jones added in tightened economic circumstances it is perfectly rational for a company to put its own interests at the heart of a decision. He noted 2005 – when the cap was introduced – was also the year non-discretionary pension increases dropped to 2.5%, so logically it should apply to a discretionary benefit. “It makes perfect sense why they did it,” he said.

Freshfields Bruckhaus Deringer counsel Dawn Heath agreed the judgment was sensible as the good faith requirement is not a particularly high hurdle. “It is an important hurdle,” she added, “but one that, provided employers have taken the decision in a manner that is not irrational or perverse, is not the same as being a trustee and thinking about the best interests of the members.” Heath added: “It is helpful because to the extent employers continue to give discretionary increases they will have the comfort of knowing, provided their communications are clear, they can do so without worrying that they should change how they exercise their discretion on a regular basis to avoid falling foul of this – which would be silly.

2.  A discretion cannot be turned into a guarantee.

Allen & Overy acted on behalf of Prudential. Lawyer Jane Higgins explained exercising a discretion under a pension scheme over a certain period of time does not turn it into a guarantee. “The circumstances in which it might become a guarantee are very narrow. If for example you told somebody you would exercise the discretion in a certain way and they then relied on it to their detriment in that case there could be a guarantee but the judge found that was not the case here. That is important to other employers who provide discretionary benefits under their pension scheme.” Indeed, paragraph 52 of the judgment said: “Prudential was not thought to have guaranteed or committed itself to such increases.”

Maurice Turnor Gardner partner Jenny McKeown pointed out capping discretionary increases without warning was not ‘perverse’ if it was always known to be discretionary. “It is disappointing that the evidence was not stronger for the duty of good faith point,” she said. “I think all the arguments failed because there was no evidence of a promise or guarantee – let’s hope the next case has stronger evidence.” McKeown predicted the judgment will make companies comfortable making scheme changes, as long as they have not at any point made any promises or guarantees to members in the documentation sent to them. “At least now we know what the test is people will sit back and look at their evidence to see if they have something to push it into the ‘perverse’ category,” she added.

On the other side of the coin, Sackers acted on behalf of the members. Senior associate Arshad Khan said the judgment was “very disappointing” and a missed opportunity to look at, and expand on, the legal test of what constitutes good faith, first set out by the Imperial Tobacco case in 1991. Khan said: “This was an opportunity to see where the law should develop since the Imperial Tobacco case. It has not made a step forward to make the obligation more relevant and have more teeth so employers stop a bit more in their tracks rather than carry on regardless.” Members argued those affected by the change got a letter on 1 April, 2006 saying their discretionary increases would be capped at 2.5% without any prior warning. “Good faith should have a procedural as well as substantive element,” said Khan. “One of the arguments was how can you be acting in good faith if you just overnight, without any warning, tell us what you are going to do? That is unjust – but the judge was not persuaded.” Khan added the judge’s decision that the company does not have an obligation to engage in genuine negotiation puts companies in a strong position. “It enhances their bargaining capability,” he said. “It can only be seen as more of an encouragement for employers to get over a low hurdle of not being perverse or irrational and then being able to do what they feel is right for the commercial interests of the company. “Shareholders and policyholders that invest in Prudential are the ones who are gaining from the costs saving in the scheme that would otherwise have gone to the pensioners.”

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