Trustee focus: GMP Equalisation – Light at the end of the tunnel?
The issue with GMPs
Contracting out of the second tier of the state pension became possible in April 1978. This 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. While GMPs ceased to accrue after 5 April 1997, the liabilities 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 and they built up at different rates, reflecting the earlier payment age for women.
Schemes have known there was a potential issue since 17 May 1990 when the ECJ ruled in the Barber case that the right to equal pay between men and women also applied to occupational pension schemes. However, the many complexities of dealing with the GMP issue 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 this problem.
What the court decided
- In broad terms, the court in the Lloyds case decided that:
Trustees are under a duty to amend schemes to equalise benefits for men and women (in relation to post 17 May 1990 service).
- Generally, trustees should not adopt the costliest method of doing this or one that interferes with benefits more than necessary.
- There are no statutory limitation periods in relation to past underpayments (both in relation to GMP equalisation and generally) but restrictions within a scheme's rules might apply.
The impact on pension schemes
Most of those affected will only see a small adjustment to their benefits. Initial estimates of the cost of equalisation range between 1% and 3% of liabilities depending on the male/ female split, the retirement age and the pattern of pension increases. Some schemes are seeing much lower costs than this. However, while there are still quite a few details to be clarified, schemes that were contracted out will all have to act and this will take time and cost money. These actions can be split into short, medium and long-term steps that trustees need to take.
Short term actions
In the immediate aftermath of the decisions, trustees need to consider their approach in relation to benefit calculations that have to be processed before any equalisation exercise can be completed. This includes deciding the best approach in relation to transfers out (in particular whether a two-stage transfer approach should be adopted or whether manual calculations could be done to equalise benefits) and whether to put trivial commutation lump sum payments on hold.
Members will need to be informed both generally and when taking specific benefits so that they
are aware that there may be an adjustment to their benefits whilst at the same time ensuring that communications do not give rise to expectations that members will receive a material uplift.
Medium term actions
Now is an opportune time to reflect on the judgment and the implications and, as the dust settles, think about the next steps for the "medium term".
One consideration is that the Lloyds judgment allowed that scheme forfeiture provisions can apply in order to limit how far back trustees need to look to correct any underpayments (for example, typically six years under a scheme’s rules). This very much depends on the rules of individual schemes, but where forfeiture is discretionary, it will be a difficult balancing exercise for trustees. The purpose of a forfeiture rule is to enable benefits to be forfeited where they have not been claimed and, in relation to a GMP equalisation exercise, will provide some cost savings to a scheme and sponsoring employer. On the other hand, fairness might suggest that it is unreasonable to limit back payments, particularly if a scheme is relatively well funded. Schemes have sat on their hands for nearly thirty years, so is it surprising that individual members have not made claims for equalised GMPs in the meantime?
Trustees should also now start to take advice on their options for equalisation – which methodology to use and whether conversion is possible. This is likely to require engagement with the sponsoring employer in order to understand its appetite for different approaches.
A lot of the decisions to be made will also be dependent on the completeness and accuracy of a scheme’s data. Trustees should start talking to their administrators to identify any gaps in data which may affect their decisions.
Longer term actions
The longer-term actions will require trustees to agree an approach and assumptions to be used where data is missing. Some actions will also depend on a further judgment in the Lloyds case in relation to past transfers and possibly in respect of whether a de minimis level can be adopted. It is not yet clear when a further hearing and subsequent judgment can be expected.
Finally, trustees will then be able to implement an equalisation methodology and to commence a rectification exercise.
GMP equalisation will be a complex exercise. Schemes have already spent the last few years reconciling GMP data against that held by HMRC. Additional, more detailed data, will be needed for equalisation and records from the 1990s may no longer be available. As such, the actuary and administrators, supported by the scheme's legal advisors, may need to suggest suitable assumptions.
There may also be an impact on other projects such as a pension buy-in with an insurance company, where the insurer will wish to ensure that it understands the liabilities it is taking on. More generally, the time spent on GMP equalisation will significantly reduce the bandwidth of both individual schemes and the pensions industry to address other important issues.
The silver lining
While the equalisation exercise will be time consuming and costly, it does provide an opportunity to simplify future administration. The court ruled that GMP conversion is an acceptable method of equalisation. This would enable the pension benefits to be reshaped so as both to equalise GMPs and change the liability into a non-GMP pension of equivalent value. This is not in itself straightforward, since the terms of conversion need to be considered very carefully to ensure that members are treated fairly. However, the resulting benefit structure would be simpler to communicate to members, e.g. when applying future pension increases, and much less complex to administer, and the liability would be more straightforward to value and hedge.
So, the pensions industry is gearing up for a lot of work and many pension scheme members will receive somewhat higher benefits. Whether the game is worth the candle is open to debate.
For more information on GMPs and the decision in the Lloyds bank case see:
- Practice note, Equalising pension benefits for the effect of GMPs.
- Practice note, Contracting out of the state second pension: overview.
- Legal update, Lloyds Bank: GMP equalisation: schemes must equalise benefits for
the effect of unequal guaranteed minimum pensions (High Court).
Reproduced from Practical Law with the permission of the publishers. For further information visit www.practicallaw.com.