In a landmark judgment, the High Court has ruled that pension schemes are required to equalise male and female members’ benefits for the effect of guaranteed minimum pensions (GMPs). This will increase the liabilities of affected schemes, a cost that will ultimately need to be met by employers and which may need to be reflected in company accounts. It has been estimated that this decision will cost FTSE 100 employers alone up to £15 billion.
This decision affects all schemes that provide GMPs in respect of service between 17 May 1990 and 5 April 1997. The trustees of these schemes need to take prompt action to equalise members’ benefits and to agree their approach with their scheme’s sponsor.
We are hosting a webinar at 9:30am on 8 November 2018 to examine the implications of this case for trustees and sponsors. If you would like to join this, please register here.
In Lloyds Banking Group Pensions Trustees Limited v Lloyds Bank Plc, the High Court was asked to decide a number of important issues. The central questions were whether the trustees of three of Lloyds Bank’s defined benefit pension schemes were required to equalise male and female members’ pension benefits for the effect of GMPs and, if so, how.
The Court has ruled that the trustees are required to equalise members’ benefits. They are also required to make back payments to make good historic underpayments (subject to a six year limitation on back payments under the rules of the schemes).
In considering how equalisation should be achieved, the Court rejected the most generous approach to equalisation, opting instead for a lower cost alternative. However, this approach still requires schemes to carry out an annual assessment of male and female members’ GMP entitlements and equalise them where necessary. This will be administratively onerous and expensive and it is unlikely that administrative systems will currently be set up to accommodate this. Trustees and sponsors may want to explore alternative options which could avoid the need for this.
What are GMPs?
Prior to 6 April 2016, the UK state pension was made up of two parts – the basic state pension and the additional state pension. During the period between 6 April 1978 and 6 April 2016 it was possible for occupational pension schemes to contract-out of the additional state pension. Where a scheme is contracted-out, the scheme took on the obligation from the State to provide the additional element of the state pension. In return, the scheme’s employers and members were entitled to pay lower national insurance contributions.
Where a scheme was contracted-out of the additional state pension between 6 April 1978 and 5 April 1997, the minimum level of benefits that it is required to provide to its members in place of the additional state pension are known as guaranteed minimum pensions.
Why do schemes need to equalise members’ benefits?
The method for calculating a member’s GMP is complex. It is calculated in broadly the same way as the state pension benefits that it replaces. During the relevant period, women were entitled to receive their state pension benefits (and therefore their GMP) at age 60, whereas men were not entitled to receive them until age 65. In addition, the formula for calculating GMPs from 6 April 1988 onwards was different for men and women. The effect of these two factors is that the GMP entitlement for a male and female member with an identical work history is almost certain to be different.
This inequality is compounded over time due to the fact that the increases payable on the GMP element of a member’s pension are likely to be lower, in most instances, than the increases payable under a scheme’s rules on the excess pension over the member’s GMP.
The combined effect of all of these factors (and others) means that in most cases a female member is likely to be entitled to a higher GMP and consequently a higher overall pension from her scheme in the years immediately after her retirement, whereas a male member may be better off than a female counterpart in later years. The position could also switch over time.
The High Court has held that the inequality in the overall pensions payable to male and female members, which result from the way that the GMP legislation works, is not compatible with the UK’s equal treatment legislation or the right to equal treatment under EU law.
How should schemes equalise?
The Court considered seven different methods that, it was argued, could be used to equalise members’ benefits. Employers will be relieved the Court rejected the most expensive approach, opting instead for a lower cost alternative.
It has been estimated that the cost of equalising members’ benefits under the three schemes in question will be approximately £100 million (in terms of additional liabilities). The cost to other schemes affected by this judgment could be considerably higher than this, or lower, depending upon the benefit design of the scheme. The rate at which pensions are revalued (up to retirement age for members who have left the scheme) and increased (once in payment) will be particularly significant in determining the ultimate cost to a scheme.
The Court’s chosen method will also require trustees to monitor members’ GMP entitlements and equalise them, where necessary, on an annual basis. This could add significantly to the cost of administering a scheme.
As well as equalising members’ benefits for the future, the Court held that the trustee is required to make back payments to beneficiaries in respect of historic underpayments. Significantly, the Court held that as a matter of general law there is no limitation on the period over which trustees are required to make good historic underpayments. However, in this case, the trustees are able to rely on limitations in the scheme rules which limit back payments to a period of six years. This may not be the case for all schemes.
The Court’s ruling on this issue could have implications for other circumstances in which members have been underpaid.
Is my scheme affected and what action must I take?
This judgment is relevant to all defined benefit pension schemes that were contracted-out on a salary related basis during the period between 17 May 1990 and 5 April 1997. It may also have consequences for money purchase schemes contracted-out during this period that have a GMP underpin.
Trustees of such schemes need to take prompt action to equalise the benefits of members entitled to GMPs. They will need to agree with their scheme’s sponsor how they will achieve this.
For many schemes, a key practical issue is likely to be the state of the scheme’s data and whether the trustees hold the right data to implement equalisation.
Are there any simpler options?
Trustees cannot avoid the need to equalise members’ benefits. However, they may be able to minimise, or even avoid, the need to track members’ GMP entitlements and equalise them on an annual basis. To achieve this, trustees and sponsors could consider:
- the extent to which there is scope to make a one-off payment to affected members who fall below a de-minimus threshold by compromising their claims, and
the merits of making use of the GMP conversion legislation, which the Court said can be used, to convert members’ GMPs (once equalised) into ordinary scheme benefits thereby removing GMPs for the future and avoiding the need to equalise them on an annual basis going forwards.
The judgment in this case raises a number of other important issues which will now need to be considered, including:
- are trustees required to equalise the benefits of members’ who have already transferred out of their scheme (this question was left unanswered by the High Court)?
- what should happen where benefits have been equalised using a method not approved by the Court, for example, as part of a buy-out?
how does the Court’s ruling that there is no statutory limitation period for historic underpayments affect other circumstances in which members have been paid an incorrect level of benefits?