Although the Lloyds Bank judgment handed down in October 2018 made it clear that GMPs must be equalised, and it provided some acceptable methods for doing so, the requirement to equalise has also raised many practical questions. An industry working group has recently published guidance to address some of those practical issues.
Although further guidance is expected and there is a further hearing on the Lloyds Bank matter scheduled for late spring 2020, steps can and should be taken now to prepare for your scheme's equalisation project.
PASA working group guidance
In September 2019, the working group set up by the Pensions Administration Standards Association (PASA) published a guidance note on the available GMP equalisation methods. The note is divided into three sections, the key points of which are summarised below.
Section A: correcting past underpayments
Past underpayments must be corrected using method B, C1 or C2, as GMP conversion (method D2 under the Lloyds judgment) can only be used for benefits which have not yet been paid. For these methods, it is necessary to use a "shadow" record for a notional comparator of each member, and equalise on a year-by-year basis. The guidance notes that a number of factors will determine which method is used (the decision is expected to be made jointly by trustees and employers). For example the additional administrative cost associated with the cumulative methods (C1 and C2) may outweigh any savings made on the reduced value of the liabilities under those methods.
The guidance notes that some clients are frustrated not to be able to apply de minimis levels to the benefits as they see little sense in spending time and money to pay arrears which could amount to a few pounds. However the guidance recommends that de minimis levels are not applied, because in most cases the majority of the work will need to be done to determine the amount. Once the amount owed is identified, the additional work to pay it will be minimal; legal advice should be taken by trustees who do intend to apply a de minimis level.
Trustees will also need to decide how to deal with what the guidance calls "no further liability" cases – these cases cover individuals for whom the scheme has no further liability as a result of, for example, the payment of a trivial lump sum or a serious ill-health lump sum, or the death of a member/survivor with no further benefits payable. The guidance notes that there are practical difficulties with these cases – a lack of data, the disproportionate cost of resolving any underpayment, and potential tax complications. Trustees could take the approach of writing to the last known address for the applicable individual and correcting any underpayment only if contact is made with the scheme.
There is also uncertainty as to the approach which trustees and employers should take as regards applying their scheme's forfeiture rule to past underpayments. The guidance notes that legal advice will be needed as to the effect of any forfeiture rule, and that some trustees have already taken steps to "stop the clock" so that the limitation period is frozen at the date of the Lloyds judgment.
Section B: approaches for equalising future benefit payments
For future benefit payments, GMP conversion is an option as well as the other methods noted above. There are pros and cons for each method, and the guidance notes that trustees and employers may decide that it is best to apply different methods to different categories of member. For example, it may be easier to continue using method B/C1/C2 for members whose benefits are already in payment, since this will already have been used in respect of their past benefits, even if GMP conversion is used for active and deferred members.
The guidance notes that, while it is not possible to compensate members for a lack of opportunity in the past resulting from GMP inequality, this issue can and should be addressed in respect of the future. 'Lack of opportunity cases' are those where the member has been denied an option that they would have been able to exercise had they been of the opposite sex. The problem will not apply where GMP conversion is used, since any restrictions arising out of the GMP legislation will no longer be relevant following conversion to non-GMP benefits. However, where any of the year-by-year equalisation methods are being used, trustees will need to consider what steps they need to take to avoid members suffering from a lack of opportunity due to GMP inequality in future. This could involve allowing "levelling up" so that all members can exercise the option in question, or "levelling down" (where legally possible) so that all members are subject to the same restrictions.
This section of the guidance also discusses the issues with GMP conversion in detail, including the question of adopting unisex actuarial factors; the extent to which benefits can and should be reshaped; the timings for converting GMPs of active and deferred members; and potential difficulties with obtaining the necessary employer consent for GMP conversion. Trustees are likely to need tailored legal advice in respect of all these aspects of GMP conversion.
Section C: common unanswered issues
The final section of the guidance highlights a number of questions which remain unanswered to date. These include:
- the treatment of past transfers in – both on an individual and a bulk basis
- the approach which should be taken in respect of members whose benefits have different normal retirement ages for different tranches of service (most likely as a result of historic equalisation exercises)
- the impact of anti-franking
- issues relating to survivors' pensions
- the treatment of schemes with a DC underpin
- divorce cases, and
- top-up schemes (historically often used for senior staff).
These and other issues are likely to give rise to further guidance in the future as the industry's position develops.
What else are we waiting for?
The PASA working group intends to publish separate guidance notes on data issues, impacted transactions, tax issues, and reconciliation and rectification of GMPs. The guidance note published in September 2019 will also be updated as and when there are material developments.
HMRC's October newsletter confirmed that guidance would be published in December 2019, focusing on the impact of GMP equalisation on the lifetime allowance, the annual allowance, and tax protections such as enhanced, fixed, primary and individual protection. The guidance should provide some clarification although it is expected to be high-level and will not cover a range of other tax-related issues which need to be dealt with in relation to GMP equalisation. Those other issues – including the treatment of crystallised lump sums such as serious ill-health lump sums and trivial commutation, and the tax issues arising in connection with GMP conversion – are to be covered in subsequent guidance notes which are expected during 2020 (HMRC has promised an update on the timetable in its December newsletter).
Employers and trustees will also be interested in the outcome of a third Lloyds judgment, due to be heard in late spring 2020, which will deal with the treatment of benefits which have historically transferred out of an affected scheme. This judgment is expected to clarify whether the transferring scheme or the receiving scheme is ultimately responsible for equalising transferred out benefits for the effects of GMP.
The HMRC guidance will be a key factor in the decisions to be made by trustees and employers regarding GMP equalisation. In the meantime, however, trustees and employers should be progressing the early stages of their GMP equalisation projects. In particular, the following actions can (and should) be taken as soon as possible:
- Trustees and employers should be setting up joint working groups and getting up to speed on GMP equalisation developments to date, if this step has not already been taken
- Trustees should urgently consider whether their rules require, or permit, the forfeiture of any benefit that has remained unpaid for a period of six years or more (legal advice will be required). If so, trustees should consider what steps a member needs to take (if any) to ‘stop the clock’. Consideration will also need to be given to the communications with members on this topic. Many trustees have already written to members to explain the judgment and what to expect going forwards
- Any outstanding GMP reconciliation and rectification exercises should be completed, and data reviews should be carried out to identify the extent of any data gaps. Once this information is known, employers and trustees should be deciding how they will deal with GMP equalisation in respect of individuals for whom the available data is not complete. Legal and actuarial advice is likely to be needed to assist with finalising the approach to be taken
- Trustees should continue to review their agreed approach to GMP equalisation in the context of "business as usual" actions such as transfer requests. The evolving landscape, including the development of industry practices and the new guidance which is being published by various bodies, could mean that decisions made soon after the first Lloyds judgment are no longer appropriate. As such, GMP equalisation should be a rolling agenda item for all trustee meetings.