Virgin Media pension ruling: sponsor entity and auditor considerations

In July 2024 the Court of Appeal upheld a June 2023 High Court ruling that may have far-reaching consequences for some defined benefit pension schemes. The case, brought by the trustees of the NTL Pension Scheme against Virgin Media Ltd, considered the implications of section 37 (s37) of the Pension Schemes Act 1993, which required an actuary to certify amendments to scheme benefits for contracted-out schemes. Under section 9(2B) of the Act, schemes that were contracted out of the additional state pension were required to provide benefits at least equivalent to a minimum level laid out in a hypothetical “reference scheme”. This was known as the reference scheme test. When amendments were subsequently made, s37 of the Act required scheme actuaries to certify that the scheme still met this standard.

According to the court’s decision, any amendments to scheme benefits that affect members’ section 9(2B) rights during the relevant period will be void unless confirmation from the scheme actuary was obtained, in writing, when the amendment was made. The ruling may affect schemes that were contracted out of the additional state pension at any point between April 1997 and April 2016, when contracting out was abolished.

There is currently much uncertainty within the pensions sector about how the ruling should be reflected in scheme and employer reporting. The July 2024 ruling has not completely settled the matter. The presiding judge included a footnote in the ruling noting a possible argument that amendments might become valid when the actuary next re-certifies the scheme as part of the triennial valuation process. Another legal case is due to be heard in 2025. The outcome may provide more clarity on this point.

It seems likely that there will be further cases to settle some of the other uncertainties that remain, such as whether whole amendments will be deemed invalid if no actuarial certification can be located, or just the parts of amendments that relate to section 9(2B) rights. Various industry bodies have called for the Department for Work and Pensions (DWP) to make regulations to validate any amendments that are held to be void solely because a written actuarial confirmation cannot be located.

Extant regulations have not changed as a result of this ruling. However, the case has confirmed what will happen if trustees cannot demonstrate that a written s37 confirmation was obtained from the scheme actuary when amendments were made to scheme benefits. The effect of the ruling is therefore the same as any other execution risk – for example, where a deed of amendment was not signed correctly or by the necessary people. Given that pension lawyers are often involved in drafting amending documents, there may be no reason to doubt that amendments were made correctly. This means that trustees and sponsors of many schemes may have good cause to believe that the scheme is paying the correct benefits. But if there are reasons to doubt that amending documents were valid, then it is possible that the scheme may have incorrectly valued its liabilities (either overvalued or undervalued).

If an amendment is found to be void, there may be either a reduction or an increase in the defined benefit obligation. A reduction in the liability could occur if a scheme amendment that augmented benefits is found to be invalid, reducing the amount of benefits to be paid in future. In practice, where this is the case, trustees may choose to give a benefit improvement retrospectively to resolve the issue rather than change the benefits that are paid to members. An increase in the defined benefit obligation would occur where scheme amendments that reduced benefits are now found to be void.

Bearing the current uncertainties around the case in mind, auditors of scheme and sponsor entity financial statements must consider what impact (if any) the ruling may have on their risk assessment and planned procedures, as well as the auditor’s report.

If trustees believe that their scheme may be unable to locate the actuarial confirmation that should have been obtained when amendments were made, they will wish to discuss the issue with their legal and actuarial advisers to help determine the next steps. It may also be appropriate to consult the scheme sponsor. The course of action selected will depend on the specific circumstances of each scheme. Trustees and sponsors should consider whether any formal advice obtained may then be passed on to their respective auditors to demonstrate the rationale for the trustees’ chosen course of action.

Trustees who have obtained legal advice may have been recommended to take a wait-and-see approach. Potential justifications for this approach include:

• Mounting a full investigation into which and how many scheme amendments may be affected, and subsequently quantifying the impact on the defined benefit liability, is likely to be time consuming and expensive, especially where historic information has not been digitised and is only available in paper form.
• Trustees may have no reason to believe that amending documents were not executed correctly and the relevant written confirmations obtained, and therefore may assess that the risk of identifying additional liabilities is low in comparison with the expense of performing a detailed analysis.
• There is a clear possibility that the situation might change with the introduction of future regulation or following future rulings, which could subsequently render such work unnecessary. Therefore, trustees may reasonably conclude that it is not in the best interests of their members to expend scheme resources on this issue at present and wait for further developments.

This is not to say that trustees should do nothing. Trustees may, as a minimum, wish to be aware of what amendments have been made to their scheme and understand what each amendment does, as well as whether a written confirmation was required. Trustees may know whether the correct process was likely to have been followed when amending documents were being drafted. This could give an idea of the potential likelihood of the scheme incurring additional obligations, even if no formal investigation is taking place. Sponsor employers and auditors may wish to obtain such information when performing their risk assessments.

If trustees are uncertain about the above points, they may wish to take an information-gathering approach to obtain a fuller picture. Potential justifications for this approach include:

• This may be a prudent course of action where trustees believe it is likely that the correct process was not followed when rule amendments were made, and/or that any voided amendments following the ruling could result in a material increase to the defined benefit obligation. Obtaining more information is a way to gain a fuller understanding without incurring significant additional costs and might put trustees in a better position to answer questions from sponsors and auditors. This approach is scalable, so trustees can perform more or less work according to the circumstances of their scheme. 
• Even if the DWP introduces regulation allowing retrospective actuarial confirmations, trustees will still likely need to identify which amendments already have the necessary confirmation, which amendments will need a retrospective confirmation, and which amendments do not affect members’ section 9(2B) rights and, therefore, did not require actuarial certification. If this work will almost certainly need to be done at some point to resolve the issues raised by the ruling, then there may be little reason to delay. 
• In rare cases, a scheme may have made an amendment that caused it to no longer satisfy the reference scheme test, and for which therefore no actuarial confirmation can be provided, even retrospectively. Regardless of the outcome of future court cases and the possibility of government action, such amendments will result in additional liabilities, or a reduction in liabilities if benefits were augmented, as they should not have been made in the first place. 
• Trustees may also consider it prudent to undertake an information-gathering exercise if they expect it to show that amending documents complied with s37, thereby giving them confidence in their understanding of the scheme's benefits.

Obtaining additional information may be challenging as there was no requirement to append the actuarial confirmation to the amending documents, so these could be stored elsewhere. Additionally, a full legal review by a pension lawyer might be necessary to determine whether s37 was applicable to the rule change and, therefore, whether a confirmation was needed in the first place.

However, performing even a limited investigation could help trustees to make more informed decisions about what to do next. Trustees may wish to consider whether a more in-depth investigation or analysis is needed or whether, based on the evidence available, they believe that appropriate processes were followed, even if the required written confirmation cannot be located, and therefore assess that the risk of an additional liability is low.

In some situations, based on their risk assessment, trustees may decide that more detailed analysis is needed to confirm that the scheme is paying the correct benefits. Points to consider for this course of action include:

• If s37 compliance cannot be shown for relevant amendments, this approach may become time-consuming and expensive. While it may be possible to resolve some invalid amendments simply (such as by giving a benefit improvement retrospectively), others could be more complex and may require the involvement of both actuaries and pension lawyers as well as taking up a significant amount of trustee time. 
• Given the wider remaining questions, and the amount of detailed information that would be required by an actuary to calculate any additional liabilities, it may not be possible for affected schemes to arrive at a reliable estimate at this time.

As mentioned above, trustees have a fiduciary duty to protect the interests of their members and may therefore conclude that it is not a prudent use of scheme resources to perform a detailed assessment while so many uncertainties remain. Any changes made to scheme benefits as a result of such an investigation may have to be reversed later as future events provide more clarity on the implications of the ruling for schemes.

Corporate employers or sponsors of a pension scheme will wish to consider how to present the potential impact of the ruling in their financial statements. It is important to be aware that scheme and sponsor financial statements are subject to different financial reporting requirements.

Sponsor entities prepare their financial statements under either International Financial Reporting Standards (IFRS) or FRS 102. They will generally have recognised the full scheme liability on their balance sheet under International Accounting Standard (IAS) 19 or FRS 102 Section 28. These standards require entities to use the projected unit credit method to calculate the present value of the defined benefit obligation. For affected schemes, the ruling has created additional uncertainty over the measurement of this obligation, as the benefits attributed to members in both the current and prior periods may have been misstated if amendments were invalid.

Many sponsors have year-end dates of 31 December and are currently facing questions from auditors about how they intend to present the potential change to the liability in their financial statements. This section explores what scheme sponsors may wish to consider in determining how to address the ruling in their financial statements and will refer to the requirements of IFRS or FRS 102.

This option is only likely to be suitable for schemes where trustees are confident that the ruling does not apply, such as where the scheme was not contracted out or did not pass any amendments to scheme benefits during the relevant period.

Alternatively, trustees may have started investigating historic amendments and found that the required actuarial confirmations are in place, meaning that the liability has been correctly measured. A further potential scenario is that the pension scheme is not material to the sponsor entity. Therefore, it would be unlikely that any potential additional liabilities arising from the ruling would be material. 

For schemes where the situation is less clear-cut, this may still be regarded as an appropriate accounting treatment, although preparers should be aware that this approach may be challenged by auditors. Additionally, given the high-profile nature of the case, where entities have material pension schemes, their investors may expect a disclosure to be made, if only to explain why the case has no effect on the financial statements.

Preparers wanting to use this approach will wish to discuss this with their auditor as far in advance as possible and stand ready to provide as much information as possible to support their view. Such information could include details of any legal advice obtained and details of scheme amendments that were made over the relevant timeframe. Preparers will also wish to be able to demonstrate consistent good governance of the scheme by the trustees, possibly through the provision of trustee meeting minutes or other relevant documentation.

Sponsor entities should be aware that they may not be able to see and/or share legal advice that was obtained by the trustees of the scheme. Where sponsor entities plan to provide information obtained by the trustees to sponsor auditors, they will wish to discuss this with the trustees in advance to agree what can be shared. Sponsor management may wish to seek their own legal advice to share with their auditor.

As outlined above, our understanding is that trustees of most formerly contracted-out pension schemes will not have made a detailed assessment of the issues underlying the case as they apply to their pension scheme. Based on legal advice obtained, they are likely to be waiting for the uncertainties in the case to be resolved, either through the outcome of future court cases or DWP intervention, before beginning such an assessment.

Therefore, for most sponsors, it is not currently clear whether a remeasurement of the defined benefit obligation will be needed and, if in the future it becomes necessary, how the liability will change as a result. This is expected to be the baseline scenario for most schemes.

In these circumstances, sponsor entity management may wish to make a disclosure around the additional uncertainty over the measurement of the defined benefit obligation highlighted by the ruling. Disclosure should be specific to the circumstances of the individual scheme and sponsor entity. However, it might include a brief description of the case and its potential implications, as well as an indication of the continuing uncertainties in relation to the ruling, which in turn have created additional uncertainty over the measurement of the defined benefit obligation.

At present, it seems unlikely that most preparers will be able to recognise a change to the defined benefit obligation as a result of this ruling. As noted above, our understanding is that trustees of most formerly contracted-out pension schemes will not yet have made a detailed assessment. Further uncertainty about whether future court cases or regulation will address the position also has an impact. 

Even in situations where trustees have determined that it is appropriate to perform a full assessment, it is unlikely that enough information will be available to quantify the impact on the defined benefit obligation while investigations are ongoing. To quantify the impact on the liability of each invalid amendment, the following steps may need to take place before an estimate can be reached: 

• detailed legal analysis;
• administrator data analysis, dependent on the legal position; and
• actuarial analysis to quantify the impact.

If such an assessment and quantification has been made, sponsors will need to consider whether and how to recognise the change in the liability within their financial statements. Due to the different reporting requirements of scheme and sponsor financial statements, sponsor entities may need to engage their own actuary to calculate the figure that needs to be recognised in the financial statements based on the requirements of IAS 19 or FRS 102. Preparers should bear in mind that any additional liabilities recognised at this stage may have to be derecognised or remeasured subsequently as future events provide more clarity on the implications of the ruling for schemes.

Preparers would then need to decide on the correct accounting treatment for the change in the defined benefit obligation. For this ruling, it seems likely that a prior year adjustment would need to be made, as the scheme liabilities would previously have been measured on the basis of one or more void amendments and therefore historically misstated. This is because unlike previous rulings on Guaranteed Minimum Pension (GMP) equalisation, the Virgin Media ruling has not created any new requirements for schemes. It has only highlighted the consequences if existing requirements were not followed, so amendments now found to be void will always have been void.

Auditors of sponsor financial statements will make judgements about the approach that needs to be taken depending on the specific circumstances of the scheme. 

Early communication with the scheme sponsor will be important to determine what approach to take. The scheme sponsor, in turn, will wish to be in close contact with trustees to obtain information about the case that might be needed for the audit. Auditors will likely want to know what legal advice, if any, the scheme trustees and/or sponsor have received, and what actions, if any, trustees intend to take as part of the risk assessment for the audit. Other information that could help auditors to perform their risk assessment might include details of any scheme amendments that were made over the relevant time period, and/or documentation from trustees showing consistent good governance of the scheme, such as meeting minutes. 

Sponsor entities and their auditors should be aware that legal advice obtained by trustees may not always be shared with the sponsor or their auditor. Sponsors may wish to consider obtaining their own legal advice, which can be shared, or discussing with the trustees what can be provided, such as extracts of trustee meeting minutes where legal advice is discussed. 

Although trustees may not have performed a detailed investigation, it would be reasonable to expect them to have considered the situation as summarised in the section on Trustee considerations above. These considerations may provide some idea of whether their scheme is likely to be affected, which can then help to direct the audit response. Where it is expected that schemes will be affected by the ruling, it may not yet be possible to tell how material the potential impact could be, or whether there will ultimately be any impact at all. 

For most schemes where there are no fundamental doubts about the trustees’ historical ability or desire to comply with laws and perform their duty, there are unlikely to be any grounds to challenge management’s decision not to remeasure the defined benefit obligation as a result of the ruling. Auditors then consider whether management has made appropriate disclosure of the ruling and its potential implications.

In most scenarios, no modification to the auditor’s report is expected to be necessary in relation to the ruling.

If the auditor concludes that the ruling is unlikely to apply to the scheme, or if scheme liabilities are immaterial, then there may be no impact on the auditor’s report. 

Conversely, in the event that the trustee or sponsor has been able to make a reliable estimate of the impact of the ruling and recognise this in the financial statements, and the auditor considers the figure appropriate, there is also likely to be no impact on the audit report. This is expected to be unlikely at this stage.

For many engagements, auditors may encounter a scenario where scheme liabilities are material and it seems likely that the ruling will apply to the scheme, but trustees are following a wait-and-see approach or have not yet completed their investigations. In such cases, the auditor considers whether the potential effect of the ruling on the scheme has been appropriately reflected in the sponsor financial statements through either a remeasurement of the defined benefit obligation or, more likely, through meaningful disclosure. When making this assessment, auditors consider the information they have received from management and the trustees about the circumstances of the scheme.

If the auditor considers that the financial statements do not adequately reflect the issues raised by the ruling, then the first step is to discuss their concerns with management to attempt to resolve the issue. The trustees or sponsor entity management 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.

If no agreement can be reached, then the auditor may wish to consider whether there should be an impact on the auditor’s report.

An Emphasis of Matter paragraph is included in the audit report to draw attention to a matter presented or disclosed in the financial statements 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 to the sponsor entity. In these circumstances, an Emphasis of Matter paragraph might be considered if the scheme acknowledges that it has made significant amendments that could create a material future outflow of benefits based on management’s current understanding of the legal case, but the auditor doesn’t feel that the disclosure in the pension note is sufficiently prominent for users of the financial statements to understand the importance of the issue.

This approach would only be appropriate if the auditor has not concluded that they would be required to modify the audit opinion because of the ruling.

For engagements where ISA (UK) 701 applies, auditors have a responsibility to communicate Key Audit Matters (KAMs) in the audit report. If the ruling has been determined to be a KAM, it cannot also be the subject of an Emphasis of Matter paragraph.

However, it is expected that entities within the scope of ISA (UK) 701 would be of such a size that it would be highly unlikely for this ruling to be one of the most significant matters in the audit. So, for such entities, neither a KAM nor an Emphasis of Matter paragraph is likely to be needed in relation to the case.

If the auditor expects to include an Emphasis of Matter paragraph in the auditor’s report, they communicate this to those charged with governance, as well as the proposed wording of the paragraph.

A modified audit opinion is issued either when:

• the auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement; or 
• the auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.

In relation to this case, a qualification of the audit report would likely be due to a limitation of scope. Auditors would only expect to identify a limitation of scope in exceptional circumstances. Such scenarios could include situations where the available information suggests a potential material implication to the scheme from the ruling, but no legal advice has been sought by the trustees or sponsor to advise on the scheme’s position. Alternatively, there may be cases where insufficient information has been provided for the auditor to meaningfully evaluate the disclosures in the financial statements.

As discussed above, except where there are reasonable grounds to believe that the required process was not followed by trustees at the time when scheme amendments were made, there may currently be no reason to expect that additional liabilities will be incurred because of the ruling. Such grounds would consist of more than just the absence of the confirmation from the actuary. There must be fundamental doubts about the trustee’s historical ability or desire to comply with laws and perform their duty. Therefore, issuing a qualified audit report may not be a proportionate response unless it seems probable that a scheme will have an additional material liability to pay benefits as a result of this ruling. Given current uncertainties, this is a high bar.

Auditors will wish to review all the information provided, including any legal advice obtained by the scheme trustees or sponsor, before drawing conclusions on how the effects have been recognised in the financial statements.