Virgin Media v NTL: reference scheme test and “Section 37”

In June 2023 a landmark judgement was handed down in the High Court in the case of Virgin Media vs NTL Pension Trustees II Limited that could have significant implications for defined benefit (DB) pension schemes going forward.

The aim of this High Court case was to ascertain whether an amendment to a scheme’s rules was invalid in the absence of a confirmation from the Scheme Actuary under Section 37 of the Pension Schemes Act 1993. The Judge ruled that it was.

Other DB pension schemes that were “contracted out” between April 1997 and April 2016 - when contracting-out was abolished – could be impacted by this judgement. If changes were made to scheme rules but a valid “Section 37” confirmation was not obtained from the Scheme Actuary, then in such cases these changes to scheme rules could be deemed invalid. This could have implications for benefits payable to members and the funding position of these schemes.

It may take some time for the industry to understand the impact of this ruling, and for the next stages of the legal process to become clear. It is anticipated that the ruling will be appealed and, given its significance, could also be the subject of government intervention. In the meantime, trustees and sponsors to DB schemes should consider seeking legal advice as to what steps to take.

Owing to Virgin Media's massive footprint in many UK markets - through it's subsiduaries such as internet provider Virgin Broadband, airline Virgin Atlantic and former phone network Virgin Mobile - the case with NTL has garnered a lot of attention. And whilst there has already been a lot of discussion on the legal details of the case, it is also helpful to understand some of the background, including:

• What is contracting-out?
• What is the Reference Scheme Test?
• What a “Section 37” confirmation was?
• Can actuaries give Section 37 confirmations now?

What is contracting out?

From April 1978 an additional state pension was provided on top of the basic state pension. This additional pension was called SERPS until April 2002 and the State Second Pension (S2P) from April 2002 until it was removed in April 2016 when the single state pension was introduced.

Employers providing existing pension provision for their employees could choose to “contract-out” of SERPS/S2P. This meant that both the employer and employee paid lower national insurance contributions. However, in order to be able to do this, the benefits provided by such an occupational pension scheme needed to meet an adequacy test. That is, in order to contract-out, schemes needed to provide a minimum level of benefits that were (broadly) at least as generous as the additional state pension being given up.

Prior to April 1997, this minimum level of benefit was the Guaranteed Minimum Pension (GMP). Post April 1997, GMPs were replaced with the requirement to pass the “Reference Scheme Test”. It is this test that was relevant for the Section 37 confirmation that the actuary needed to give.

What is the Reference Scheme Test?

The Scheme Actuary needed to test whether the benefits provided by the contracted-out scheme were at least equivalent to those in a “Reference Scheme”. Reference Scheme benefits were a minimum level of benefits, defined in legislation. These minimum levels can be summarised as:

• a pension payable from age 65;
• based on 1/80th of “Qualifying Band Earnings” (Qualifying band earnings were determined as 90% of earnings between the Lower Earnings Limit and the Upper Earnings Limited / Upper Accrual Point (UAP), averaged over three years); and
• with a 50% reversionary spouse’s pension on death (except in some prescribed circumstances).

If the benefits of the scheme were better than the Reference Scheme Test in every way, then the actuary could confirm that the test was met without further investigation. However, this was not normally the case, and therefore the actuary had to consider whether the benefits were "broadly equivalent". This means that the actuary needed to confirm that:

• the average value of benefits in the scheme as a whole was not less than the Reference Scheme benefits; and
• at least 90% of members passed the test individually.

In addition, member benefits and death benefits (both before and after retirement) needed to be tested separately.

The test was based on the active membership of the scheme at the effective date. It compared three years of benefit accrual following the effective date (i.e. it was concerned with future service, not past service).

What was the “Section 37” confirmation the actuary was giving?

Before amendments to a contracted-out scheme’s benefits could be made, the Scheme Actuary was required to confirm that the scheme would continue to meet the Reference Scheme Test after these amendments. This requirement was set out in Section 37 of the Pension Scheme Act 1993, as expanded upon by Regulation 42 of the contracting out regulations 1996. As such, the requirement was sometimes referred to as either a “Section 37” or “Regulation 42” certification. 

The confirmation needed to be made in writing, though there was no prescribed form that the certification must take. The Scheme Actuary was also required to consider every three years that the scheme continued to meet the test. This was typically carried out alongside the triennial actuarial valuation.

Why it is not always straightforward to tell if a scheme passes the test?

The Reference Scheme Test used members’ full earnings. Many DB scheme benefits are not based on full earnings. For example, pensionable earnings definitions generally don’t include bonuses and are often linked to basic salary. 

Therefore, the Reference Scheme Test was most likely to be failed for members with lower levels of earnings (who were not subject to the upper earnings limits) but with a high proportion of non-pensionable earnings. 

Because spouse benefits needed to be tested separately to member benefits, there could also be other differences between the scheme rules and the Reference Scheme benefits which led to the test being failed. For example, differences in the timing of when spouse benefits became payable or who was eligible to receive spouse benefits.

Can Section 37 confirmations be given now? 

In light of the judgement, it is possible that actuaries may be asked to give confirmations now, either to close off any potential additional liabilities in cases where a past Section 37 confirmation cannot be found or due to a cautious approach being taken for future amendments. 

Whether such an approach would ever be necessary – or even valid – is predominantly a legal matter. 

Regardless, the challenge for an actuary here is that the Reference Scheme Test was designed to be applied to future accrual, not benefits that have already been accrued. As such, where a scheme has closed to future accrual, it’s not obvious how the actuary could provide a confirmation at a current date. 

As such, if the actuary is being asked to give a confirmation, they need to be clear as to what they are being asked to confirm, what the effective date of the confirmation is and what investigations they have carried out in doing so, including what membership data they have used.

Actions for DB trustees and sponsors

It is understood that the judgement in the Virgin Media vs. NTL case will be subject to an appeal. Given the potential implications of the judgement in this High Court case, many trustees and sponsors of DB schemes will be holding their breath waiting to see what further developments there are in relation to this case. 

In the meantime, this is an issue where trustees should seek input from their legal advisors, especially for any schemes undertaking a bulk annuity transaction either now or in the near future.