Pension Loss Calculation

David Marshall, Partner
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Overview 

Loss of pension rights is an important consideration for many personal injury claimants. A career cut short by injury may lead not only to loss of future earnings up to retirement age, but loss of pension income or lump sum from retirement as further contributions to the fund will not be made.

However, the prospect of pension loss claims can create panic in practitioners. This is partly due to the general lack of understanding of or indeed ‘belief’ in pensions in society generally (and perhaps particularly by those many professionals who may have had Equitable Life pension funds), partly due to the possibly unrealistic expectations of clients and partly due to the perceived complexity of the mathematics (which frankly has not really been helped by judicial intervention).

Types of pension

The key distinction is between final salary/defined benefit schemes and money purchase/defined contribution schemes:

Final salary/defined benefit schemes give the employee the right to a pension on retirement which is usually dependent upon multiplying the final salary earned in the job by the years served subject to a factor established in the scheme rules (e.g. £30,000 x 20 x 1/80 = pension of £7,500 per annum gross). The pension does not depend upon the performance of the pension fund. That risk has been assumed by the employer who will have to top up the fund if investment has been inadequate. Final salary schemes are increasingly rare and are now most often found in the public sector. Most valuable are schemes such as the army or the police where full pensions can be drawn at a relatively early age.

Money purchase/defined contribution schemes give the employee the right to a pension on retirement which depends upon the investment performance of the contributions invested. In other words, no pension of any sum is guaranteed. This will include many occupational pension schemes where the employer contributes, or where he matches employee contributions, personal pension plans and stakeholder pensions. (Many Additional Voluntary Contribution (AVC) add-ons to a final salary scheme are also in effect money purchase add-ons).

State Pension : There is a state basic pension and also an earnings related additional state pension (full entitlement to which depends upon national insurance contribution record). Potential loss is usually small and complex to calculate – see below. 

Case law 

In principle, if the claimant can prove that he will suffer a diminished pension by reason of the injury, he is entitled to be compensated. However, the loss will fall in the future, perhaps far in the future, and the judiciary have traditionally been wary of what they might consider ‘speculative’ future loss. All case-law discussed here applies to loss of pension under final salary/defined contribution schemes. For money purchase/defined benefit schemes, loss is far more speculative for the reasons set out below.

Basis of Calculation: Auty & Wells

The leading case on pension loss remains the Court of Appeal decision in Auty v National Coal Board [1985] 1 W.L.R. 784. The decision in this case is still technically good law (whatever practitioners may think of its reasoning), but as we shall see it has almost certainly been superseded in certain respects by Wells v Wells [1998] UKHL 27, so that a pure Auty approach is not likely to be approved today.

However, although Auty has been much criticised, particularly for multiple discounts, to be fair to the Court the Ogden Tables were not available at the time. Criticisms included:

• that the rate of return utilised in the retirement date multiplier was too high at 4.5%
• the court, in practice, double discounted for the risk of death before retirement in their multiplier and their discount for contingencies of 27%
• if the discount for contingencies had excluded mortality, 27% was far too high particularly bearing in mind suggested discounts for future loss of earnings (see Ogden Tables Explanatory Notes Section B).

In Wells v Wells, the Lords in effect dealt with the discount rate point. The Lords approved 3%, and subsequently the discount rate has been fixed by the Lord Chancellor under the Damages Act 1996 at 2.5%. This should now be the rate of return used in calculations.

If there had been double discounting by the Court of Appeal for the risk of death before retirement age, this can be addressed by the use of the multipliers from the Ogden Tables. Multipliers for pension loss from ages 55,60,65 and 70 appear in the Fifth Edition of the Ogden Tables, as do discounting factors for terms certain (Table 27). Assistance in flexible calculations appropriate to circumstances is also given by a combination of the whole life tables with loss of earnings and pension multipliers (loss of earnings to retirement date multiplier + pension multiplier from retirement date = life multiplier). The use of the Ogden Tables was approved by the Lords in Wells.

So far as discount for contingencies other than mortality is concerned, this remains contentious bearing in mind the relatively low deductions for loss of earnings claims in Ogden Tables Explanatory Notes Section B. The Auty 27% deduction over 31 years seems very high even though it was for a miner, a dangerous occupation. In Wells in one of the conjoined appeals (Page v Sheerness Steel Company Limited) a 10% discount over 34 years was applied and apparently approved by the Court.

Ill-health pensions

The relationship of a lost retirement pension with early receipt of a pension on grounds of ill-health (often with enhancement) also needs to be considered in assessing the claimant’s net loss. Parry v Cleaver [1970] A.C. 1 and Smoker v LFCDA [1991] 2 A.C. 502 established that the receipt of such a pension should not be deducted from the loss of earnings claim up to retirement age as it would not be deducting ‘like for like’. However, after retirement the ill-health pension received falls to be deducted from the retirement pension that would otherwise have been payable as at that stage there is a like for like deduction. This was confirmed by the House of Lords in Longden v British Coal Corporation [1997] UKHL 52 where the Lords also established the principle of how to deal with a lump sum received prior to retirement. The lump sum:

“is a commutation in part of the annual pension to which the contributor is entitled under the scheme to which he has contributed. Thus the effect of the lump sum which the plaintiff actually received in this case was to reduce the amount which he has received and will continue to receive for the rest of his lifetime by way of his annual pension.”

The Court held that was necessary to apportion the lump sum so that:

“ in order to compare like with like, the plaintiff should be required to set against his claim for the loss of the retirement pension an appropriate portion of the lump sum which he received on his retirement on the ground of incapacity”

This is done in practice by calculating the percentage the multiplier for pension loss at retirement age bears to the multiplier for pecuniary loss for life (e.g. 11.66/14.49 = 80.47%) and applying this percentage to the lump sum actually received gives the amount to be credited. If actually received before trial, this sum may need to be increased to take account of investment return (multiply by 1.025% per annum) (LAS v Swain [1999] EWCA 996).

Factoring in the chance of early retirement

In Brown v Ministry of Defence [2006] EWCA Civ 546 the Court of Appeal recently considered the issue of how one deals with the chance of the claimant not working through to retirement age and receiving the full occupational pension. Linked with this issue is the question of the appropriate multiplicand for pension loss.

The Claimant came from an ‘army family’. Having joined the army at the age of 24 she suffered an injury eight weeks into her service and retired. There was a limited claim for future loss of earnings as she retrained as a physiotherapist. However, her claim included nearly £150,000 for loss of pension rights assuming a full 22 year service. The Defendant contended that the average length of serve for female recruits was 6 years. The Judge found that she would probably have served 22 years with promotion to Staff Sergeant, with a 30% chance of promotion to WO1 by the end of her service.

The Court of Appeal pointed out that in Herring v Ministry of Defence [2003] EWCA Civ 528, although the pension loss claim had received less attention than the loss of earnings claim, the Judge had applied a 25% Auty-style reduction which would deal with contingencies such as retirement early.

Normally, the Court felt that contingencies can be dealt with in this way:

“Provided a fair career model is chosen as the basis for the assessment of loss of future earnings and pension entitlement, the prospects of enhanced or reduced earnings resulting from the ordinary chances of life can be allowed for by adjustments to the multiplicand and multiplier as appropriate. It is only when the court has to consider the possible effects of an unusual turn of events that would have a significant effect on earnings or pension rights that it is necessary to assess the chances of such events occurring and to assess their financial consequences”

But in this case because:

“if she left after serving a full term of 22 years she would have become entitled to an immediate pension instead of having to wait until the age of 60. That was an unusual factor which would have had a significant effect on the value of her pension rights.”

the Court set out principles for calculation of the loss (which they remitted to the Court):

Chances to be applied 
 

This follows the style of the ‘loss of a chance’ promotion calculations approved for loss of future earnings in cases such as Langford v Hebran [2001] EWCA Civ 361.

Calculating loss for established final salary scheme members

Final salary/defined benefit schemes are increasingly rare and valuable to employees. Pension loss claims should always be considered in such cases. Increasing life expectancy (taken into account in recent editions of the Ogden Tables) means that multipliers are higher and such claims are increasingly significant.

First obtain the scheme rules and/or explanatory booklet. The claimant may have them (but probably will not). The employer may have them, but may not have the appropriate details. The most obvious source for the information are the pension fund trustees, although they can sometimes take time to respond. The explanatory booklets of some schemes are available on the internet.

You need to establish:

• How is final entitlement calculated (1/80 etc)?
• When did pensionable service begin?
• What is final ‘pensionable pay’
• How is lump sum entitlement calculated?
• Early retirement provisions (ill-health or otherwise)?
• If the claimant has retired, what is current actual entitlement and how much was paid as a lump sum?

Once the basic information has been gathered, the loss can be calculated. It may later be necessary to seek further clarification form the pension fund trustees or to obtain expert evidence, but this should not be necessary at the outset in most cases.

All sums should be as at the value at the date of trial (present day value) not at date of retirement. So the Claimant’s multiplicand for loss of earnings net of tax as contended for (adjusted for vagaries of ‘pensionable pay’) will be the starting point for the lost pension calculation. If the claimant has retired then the actual net pension receipt will be set against this. If the claimant has not retired, the pension fund trustees will provide a calculation of the present day value of the claimant’s accrued pension rights. This must be calculated net of tax. The potential lump sum has to be discounted for early receipt at trial. Part of any actual lump sum received or to be paid (see Longden) must be credited. A discount for other contingencies will be then applied.

Example calculation

Male claimant age 50. Would have worked until retirement at 65. Pre-accident earnings: £50,000 gross. 

Particularly in the case of young claimants who are recent entrants to the scheme, regard should be had to Brown v Ministry of Defence and consideration given as to whether a prospective chance model should be applied instead of a general discount for contingencies.

For further information email David Marshall or call 020 7940 4000.