Education pensions briefing: GMPs – an answer at last?

• United Kingdom

• Education - Briefings

12-12-2018

A recent decision by the High Court in a case involving Lloyds Bank has held that pension schemes must equalise the discriminatory effects of Guaranteed Minimum Pensions (GMPs).

The decision affects all pension schemes and those institutions with their own defined benefit (DB) pensions schemes or which participate in the Universities Superannuation Scheme (USS) should take note.

The national/public pension schemes are taking action to address the outcome of this case:

• We understand that the Trustees of the USS are considering the funding impact of the Lloyds case, although they do not anticipate the cost implications will be ‘significant’.

• As part of the 2017 actuarial valuation, the SAUL trustees set aside a provision of 1 per cent of their liabilities to address GMP equalisation issues. The SAUL trustees are now considering the implications of the Lloyds case ruling on the scheme.

• Public service schemes, including the Teachers’ Pension Scheme, the NHS Pension Scheme and the Local Government Pension Scheme, have put in place interim solutions to ensures that GMPs for individuals retiring after April 2016 (when the new State Pension was introduced) were fully indexed, and HM Treasury’s view is that this interim solution also ensures full equalisation, so that the Lloyds case will not affect public service pension schemes. The point is not entirely free from legal doubt, however; and in any event, responses to the Government’s consultation in relation to GMP indexation and equalisation in public sector schemes strongly favoured GMP conversion as a longer-term solution. We are likely to have more clarity on how this will be taken forward once the Government formally responds to the Lloyds decision.

The case also raises a number of issues for private DB schemes, many of which will need to be worked through over the longer term. However, there are some immediate issues which apply to both institutions and trustees of DB schemes. Institutions will need to consider how this is likely to affect the funding level of DB schemes they sponsor and may need to consider referencing the additional liability in their accounts, even if it is as a contingency. Trustees of DB arrangements will need to consider their approach on a number of issues such as transfer payments, commutation (especially trivial commutation and serious ill health) and divorce cases.

Summary

Following 25 years of uncertainty, the High Court has held that schemes must equalise the discriminatory effects of GMPs.

In broad terms, the court decided that:

1. Trustees are under a duty to amend schemes to equalise benefits for men and women (in relation to post 17 May 1990 service) to ensure that equal benefits are paid;

2. Generally, trustees should not adopt the most costly method of doing this or one that interferes with benefits more than necessary. The court’s preferred option was broadly an annual check to see who was better off overall;

3. There are no statutory limitation periods in relation to past underpayments (both in relation to GMP equalisation and generally) but provisions in scheme rules might help.

Trustees and sponsors need to consider the impact of this judgment on their schemes now and what steps they need to take. However, they may wish to wait before actually equalising benefits until (a) it is known whether the judgment will be appealed and (b) DWP has had a chance to respond and indicate whether it is going to update its suggested method of equalisation.

What is the problem with GMPs?

Contracting out of the second tier of the state pension became possible in April 1978. It provided for reduced employer and employee National Insurance contributions in return for members receiving a pension from an occupational pension scheme of at least a guaranteed amount (the GMP).

While GMPs ceased to build up on 5 April 1997, they remain in schemes today.

GMPs are unequal between men and women in various ways. For example, they are payable at age 60 for a female member and age 65 for a male member.

In addition, GMPs build up more quickly for a woman than for a man. This is because the full GMP entitlement is built by age 60 for a woman, whereas a man has until age 65.

Schemes have known there was a potential issue since 1990 (the Barber decision) but the sheer complexities of dealing with the problem have meant that there has never been a clear solution.

In addition, as GMPs reflect statutory requirements and state benefits - which under European law can have different payment ages for men and women - there have always been arguments that nothing needed to be done about them.

What does the case decide?

The Trustee of several Lloyds Bank schemes asked the court three key questions:

1. Must the Schemes equalise benefits for the discriminatory effect of GMPs?

2. If so, how? and

3. What should be done in relation to past underpayments and transfers?

Looking at each question in turn:

Obligation to equalise?

The High Court has answered yes to this question:

“The Trustee is obliged to adjust the benefits payable under the Schemes in excess of the GMP in order that the benefits received by male and female members with equivalent age, service and earnings histories are equal”.

How should equalisation be achieved?

The court was asked to consider four alternative methods:

• Method A: equalise each unequal aspect of benefit separately;

• Method B: provide the better of male or female benefits each year;

• Method C: provide the better of male or female benefits each year, subject to accumulated offsetting;

• Method D: a one off actuarial equivalence test.

The judge rejected Method A on the basis that it did not comply with the principle of “minimum interference”. This is that:

“‘The court should, where possible, give effect to Barber rights by adhering to the provisions of the relevant scheme where it is possible to do so in preference to some other approach. If some departure is required, it should in general, so far as practicable, represent the minimum interference with the scheme provisions” (Foster Wheeler v Hanley).

Method C was possible provided that when doing the calculations, interest was added to the value of payments already made.

A straightforward actuarial equivalence calculation under Method D also failed to comply with the minimum interference principle. However, it would be permissible for trustees to equalise benefits in line with Method C and then convert the GMPs to equivalent non-GMP benefits in accordance with provisions in the Pensions Act 1993.

Method B was also ruled out on the basis that it was significantly more costly than Method C and therefore, again following the minimum interference principle, the employers were entitled to say that the Trustee must adopt Method C.

What should be done for the past?

The rules of the relevant schemes contained provisions which allowed for forfeiture of unclaimed benefits after 6 years. The judge thought that this would include claims for underpaid benefits.

However, the court did not consider that the Limitation Act 1980 could be used here (or more generally in relation to underpayments).

The parties requested that they be allowed to consider the best way forward in relation to transfers out of the schemes in light of the judgment and therefore, the judge did not rule on that point.

What is the Government’s position?

Arguably, as this is a problem caused by compliance with legislation, the Government might have been expected to sort it out. However, successive governments have said that, although there was in their view a clear obligation to ensure the equality of overall benefits, it was for each scheme to determine how to do this.

In 2012, DWP published a draft methodology suggesting how schemes could tackle the problem. This was criticised by both the court and the industry as extremely costly however.

In 2016, DWP tried again and suggested another alternative. This would require a one-off assessment of whether a male or female member was better off (in line with Method D). The worse-off member would be topped up and then all post-May 1990 GMPs would be converted to non-GMP benefits. This would prevent future inequalities arising because of the effect of revaluation and increases on the GMP.

The Government was in the process of working with an industry group to address problem issues with this solution, including the treatment of historic transfer payments, past under and overpayments and tax implications, when it became clear that the issue was going to go before the courts. The Government then decided to wait for the outcome of the case.

Now the High Court has said that equalisation is required and conversion is possible, we may see a revised version of DWP’s proposed methodology published in coming months.

What next?

The decision is not necessarily the final solution to the difficult question of what schemes should do with GMPs. We understand that it may well be appealed and in a post-Brexit world, the Court of Appeal may feel less constrained by the requirements of European law.

However, in the meantime the decision should bring GMPs to the forefront of trustees’ agendas.

They should consider:

• Obtaining actuarial advice on the likely costs of any equalisation exercise.

• How equalisation interacts with their GMP reconciliation exercises – is it possible (or even helpful) to do a single exercise to correct benefits?

• How should any past underpayments be dealt with?

• Whether there is sufficient data to do any required calculations and whether anything needs to be done to improve data?

• What (if any) communications might be required to manage member expectations?

• What should be done in the short term where members are seeking to transfer-out and their final post-equalisation benefits are not known?

• Although the judgment only requires equalisation of benefits built up from 17 May 1990, trustees may also want to consider what their approach will be to pre May 1990 GMPs.

• Whether the exit of the UK from the EU may impact the position in any way?

This is clearly not just an issue for trustees. GMPs can lead to differences in otherwise identical benefits of several thousands of pounds over time and as a result, the estimated cost of equalisation to the industry is in the region of £20bn.

Trustees should be talking to their sponsors now and sponsors may wish to consider discussing with their accountants what impact this additional liability might have on their accounts.

We are still not at the end of the GMP story but perhaps it is in sight and all schemes and sponsors with GMP liabilities should be talking to their advisers about how to proceed now.