The recent High Court judgment in Lloyds Banking Group Pensions Trustees Limited v Lloyds Bank plc and others (Lloyds) will have a significant impact on the many defined benefit pension schemes which were historically contracted out. It is possible that the judgment will be appealed and we would advise waiting until the appeal period has expired (yet to be confirmed, probably first quarter 2019) before implementing any changes to align your scheme with the decision, but if your scheme was formerly contracted out, you should be considering what steps to take in light of the decision.
Since the Barber judgment on 17 May 1990, when the European Court of Justice decided that pensions were "pay" and that the principle of equal pay requires pension schemes not to discriminate on the grounds of sex, most defined benefit schemes have taken action to equalise benefits. However, most schemes did not equalise guaranteed minimum pensions (GMPs) because GMPs were intended to reflect the additional state pension at that time which was, without question, unequal.
Until 2016 defined benefit pension schemes were able to contract out of the additional state pension. Schemes which were contracted out on a salary-related basis before 6 April 1997 are required to provide GMPs to, and in respect of, members who accrued benefits in the scheme before that date. The calculation of GMPs is set out in legislation, and they are inherently unequal for a number of reasons, not least because they come into payment at different ages for women and men (age 60 and 65 respectively).
The Lloyds decision
Obligation to equalise GMPs. The High Court held that GMPs fall within the definition of "pay", meaning that schemes are under an obligation to equalise GMPs for the period between 17 May 1990 (the date of the Barber judgment) and 5 April 1997, after which GMPs stopped accruing
Possible equalisation methods. A number of possible methods of equalisation were considered. Based on the principle of minimum interference (under which the method used for equalising benefits should be the one which results in the least possible interference with the rights of any party), the judge concluded that the least costly method (carrying out a one-off actuarial equivalence calculation rather than a comparison of the actual benefits accrued with the benefits that would have been accrued by a member of the opposite sex) would be unsuitable from the perspective of members and beneficiaries because it was based on general assumptions about members rather than the benefits to which they are actually entitled under the pension scheme
Preferred equalisation method for Lloyds schemes. The judge concluded that the trustees were required to do what was necessary (and no more) to equalise benefits. Anything more expensive than implementing an appropriate equalisation method was not within the scope of the trustees' unilateral powers. Accordingly, the method referred to in the judgment as "C2" – providing the better of male or female comparator pensions each year, but subject to accumulated off-setting (with interest applied to the accumulated gains) – was held to be the only option available to the trustees unless the sponsoring employer agreed to one of the more expensive methods
Arrears for pensions already in payment. The judge decided that for pensioners and beneficiaries who are receiving pensions, if the pension paid to date is less than the pension that would have been paid had equalised benefits been paid, the shortfall should be paid as arrears. The extent of the look-back period for calculating arrears could be from the date the benefit commenced unless the forfeiture provisions in the scheme rules allow the look-back period to be limited in a way that does not contradict legislation
Transfers in and transfers out. It was confirmed that trustees are required to equalise GMPs in relation to benefits which accrued in other schemes after 17 May 1990 and which subsequently transferred into the scheme. The question of whether trustees are required to equalise GMPs in relation to benefits which have been transferred out of the scheme prior to the Lloyds decision was parked. The parties have an opportunity to ask for a subsequent hearing to decide this issue but it remains to be seen whether the parties will agree amongst themselves without the added expense of another hearing.
What do I need to do?
You or your advisers may have identified a number of issues as a result of this decision that need to be dealt with. At this stage, we recommend that only necessary decisions are taken – GMPs have already been unequal for many years and a GMP equalisation exercise will take time; a rush to equalise could result in problems further down the line. Parallels can be drawn with the many flawed attempts at equalisation of pension benefits in the immediate aftermath of the Barber judgment.
The first step is to identify what decisions will need to be made, which decisions need an urgent decision (perhaps on an interim basis) to allow your scheme to continue "business as usual" such as dealing with transfer requests, and which decisions can be postponed.
Some of the issues we are currently looking at for clients in light of the Lloyds decision are discussed below.
It is possible that a further hearing in the Lloyds case will detail how previous transfers out made by schemes should be equalised (if equalisation is in fact required). There is unlikely to be an urgency for trustees and employers to address transfers they have made prior to the Lloyds judgment being handed down.
In dealing with a future request for a statement of entitlement (transfer quotation), there is no risk-free approach. Trustees should balance the risk of failing to meet the statutory timescales (incurring potential Pensions Regulator fines, Pensions Ombudsman awards and the wrath of members) with the risk of failing to receive a valid discharge if the transfer is based on benefits that have not been equalised. Trustees may prefer to continue business as usual and pay "top-ups" once a method has been decided with the employer and implemented.
- Communicate with members. Most schemes are continuing to quote and pay transfer values; for some schemes, actuaries are able to provide revised calculations to take into account equalisation on an agreed method, other schemes plan to make top-ups at a later date. If you provide a statement of entitlement, it should be clear what the transfer value represents and the extent to which the trustees are discharged from their liability to the member. We can help with drafting suitable wording. Failing to provide a statement of entitlement within the statutory timescales could incur a penalty of up to £10,000 from the Pensions Regulator and a complaint to the Pensions Ombudsman.
- Mitigate risk. We suggest that schemes identify what proportion of members have a right (under statute or the scheme rules) to transfer out. This depends on the wording in your scheme rules, what the normal pension age is for members (usually different from normal retirement age), when defined benefit accrual ceased and whether a statement of entitlement has been provided to the member in the previous 12 months. Many scheme rules give the trustees a discretion to pay out non-statutory transfer values; other rules give the member an entitlement to a transfer value irrespective of the statutory wording. Many schemes do not distinguish between paying statutory transfer values and discretionary transfer values, and trustees may be able to mitigate the risk and limit the number of potential "top-ups" paid by only paying transfer values for those members who have a right. We can advise on the normal pension age of your scheme and whether trustees can restrict the category of members who are entitled to a transfer out.
- Check trustee protections. Ideally, trustees will receive a statutory discharge, a member discharge and a scheme discharge when a member's benefits are transferred out. The uncertainty around GMP equalisation means that there is a risk that the transfer will not extinguish the entire benefit to which the member is entitled, possibly invalidating any discharge. An additional element of benefit could remain in the scheme. Trustees should consider the scope of the exoneration and indemnity provisions in the scheme rules and whether additional protections (such as a separate indemnity from the employer, or a waiver by the member) would be appropriate.
2. Method for equalisation and scheme amendments
Trustees and employers should work together to agree the most suitable equalisation method. A number of our clients have set up a subcommittee to consider the most appropriate method and to identify remedial steps. Actuarial availability and input will be key. Some clients are interested in converting GMPs to "normal" scheme benefits; the DWP is to issue further guidance on this in due course and employer consent is required. A subsequent hearing (handed down on 6 December 2018) confirmed that conversion does not necessarily have to be a two-step process which means it could be the preferred method for many clients.
The Lloyds decision confirmed that scheme rules will need to be amended. Our clients are obtaining legal advice as to whether the scheme's amendment power is broad enough to implement the necessary changes (and, if not, whether the statutory override route can be used).
The Lloyds judgment made clear that statutory limitation periods do not apply, and that consequently the forfeiture provisions in the relevant scheme rules will dictate the extent to which backpayments must be paid to members who have received underpayments due to inequality of GMPs.
Contrary to some published material, Lloyds did not give all schemes permission to limit calculation of arrears to a six-year look-back period. It is vital that scheme provisions are reviewed, if you intend to restrict the period by which you calculate arrears.
Key issues and suggested actions:
- Check the forfeiture provisions in your scheme rules. Do you have one? Was it validly introduced? Does it comply with the statutory requirements relating to forfeiture? Is it discretionary? What factors should you take into account in exercising any discretion?
- When does a "claim" arise? If you do have an automatic forfeiture clause that is valid (or you exercise a discretion to apply a valid forfeiture clause) what date is used from which you look back? Does a member have to bring a claim? Further court decisions may help address these questions.
- Does applying a limitation period always decrease liability? If one of the off-setting methods is used to equalise benefits, restricting the look-back period could reduce the amount you can "set-off", thus bringing the date at which the member commences to receive the comparator's pension forward. Actuarial analysis will be needed on this point.
The judge noted that the actuarial equivalence method is generally used to equalise GMPs when benefits are being bought out. This point was not argued extensively before the judge but, based on the limited comments in the judgment, it seems unlikely that completed buy-out exercises (not buy-in exercises) will need to be revisited.
For schemes which currently hold a buy-in policy or are considering a buy-in and/or a buy-out, the decision will have an impact on the approach to GMP equalisation which is ultimately agreed between the trustees and the insurers. There could be some merit in converting GMPs to "normal" scheme benefits as part of a housekeeping exercise to obtain lower quotations from insurers, as future administration of the benefits will be less complex after conversion.
Please get in touch with your usual contact in the pensions team if you would like to discuss anything in relation to GMP equalisation.