Welcome to our spring edition of Trustee Agenda for 2020.
In this edition, we share answers to "frequently asked questions" on GMP equalisation. Whilst several developments in this area are expected in the coming months, we hope that these answers may help equip trustees to begin (or progress) the complex task of GMP equalisation for their schemes. We will continue to share FAQs as thinking in this area evolves.
Following the recent Supreme Court case confirming that opposite sex couples are now able to become civil partners, we include an article on what this means for pension schemes and what, if any, changes to scheme rules are needed. From time to time, we place the spotlight on perennial issues facing trustees. This edition offers a guide to deciding ill-health early retirement applications, an area of trustee activity that can become complex, particularly where there is a need for interface with a number of parties such as health professionals and the employer's HR function. Finally, we look at recently updated Pensions Regulator's guidance on DB to DC transfers. As always, do let me know if there are any particular topics or issues you would like to see covered in future editions of Trustee Agenda.
FAQs on GMPs
> It is over a year since the High Court handed down its landmark decision in the Lloyds case, confirming that trustees are under a duty to equalise for guaranteed minimum pensions (GMPs), but many trustees are yet to make a start on their GMP equalisation projects. The reasons for this are varied, but we often hear that there are still too many areas of uncertainty for trustees to proceed.
> While it is true that several developments are expected in the coming months, this should not prevent trustees from starting work on GMP equalisation now. We aim to provide greater certainty for trustees by answering many of the questions frequently asked by trustees about GMP equalisation.
The introduction of opposite sex civil partnerships
> After years of campaigning to change the law, opposite sex couples are now able to become civil partners. Rebecca Steinfeld and Charles Keidan won their legal bid to enter into a civil partnership at the Supreme Court in 2018 after a five-year landmark legal battle. Following their victory, the couple entered into an opposite sex civil partnership on 31 December 2019.
> This article looks at the implications of this decision for pension schemes.
4 In summary
A guide to deciding an ill-health early retirement application
> Decisions about whether or not to pay an ill-health early retirement pension (sometimes called an incapacity pension) are not always straightforward.
> In this article, we provide trustees with guidance on the process they should follow when considering a claim for an incapacity pension. While not exhaustive, the article provides information about the factors trustees should consider in their decision making. It focuses on the questions trustees should ask of the medical advisor and the actions that should be undertaken to reduce the likelihood of challenge or to defend a decision in the event that a member challenges the decision made.
DB to DC transfers: the requirement to obtain appropriate independent advice
> For transfers of DB benefits worth more than 30,000, trustees must check the member has received appropriate independent advice before transferring their benefits.
> The Pensions Regulator has recently updated its guidance to suggest that, as well as checking that the company or business providing the advice has permission to carry on the regulated activity, trustees should also check that the relevant individual works for that firm. Trustees may wish to add this step to their existing processes as a matter of good practice.
FAQs on GMPs
It is over a year since the High Court handed down its landmark decision in the Lloyds case, confirming that trustees are under a duty to equalise for guaranteed minimum pensions (GMPs). Pensions Minister Guy Opperman has been quoted as saying "it is time for pension schemes to act to equalise GMP payments". But many trustees are yet to make a start on their GMP equalisation projects. The reasons for this are varied, but we often hear that there are still too many areas of uncertainty for trustees to proceed.
While it is true that several developments are expected in the coming months (see box), this should not prevent trustees from starting work on GMP equalisation now. This article aims to provide greater certainty for trustees by answering many of the questions frequently asked by trustees about GMP equalisation. If you have any questions not covered by this article, please speak to your usual Linklaters contact.
We expect to include further FAQs on the tax issues arising in relation to GMP equalisation in a future edition of Trustee Agenda.
Developments expected in the coming months:
> The government has said it is considering changes to the GMP conversion legislation "to clarify certain issues".
> The government has said it intends to amend the Equality Act 2010 to remove the requirement for a comparator "as soon as a suitable opportunity presents itself". In practice, this will not make any difference to schemes, as most are proceeding on the basis that GMP equalisation is required even in cases where no opposite sex comparator exists.
> HMRC has published guidance on GMP equalisation. This covers pensions tax issues relating to the annual allowance (including the deferred member carve-out) and the lifetime allowance (including fixed, primary, individual and enhanced protection). HMRC says it is continuing to explore the pensions tax issues not covered in the guidance, including the treatment of lump sum and death benefit payments, and it is aiming to give more guidance on these "as soon as possible". HMRC is also continuing to explore the tax implications for schemes choosing GMP conversion.
> The industry-wide GMP equalisation working group has already published a call to action, as well as good practice guidance on GMP equalisation methodology. Further good practice guidance is expected to be published in the coming months on data, tax and
impacted transactions. Impacted transactions are those which need to be completed now but, if the scheme still has not equalised for the effects of GMP, may need to be revisited as part of an equalisation project.
> A further hearing in the Lloyds case has been scheduled for the end of April/beginning of May 2020. The hearing is expected to look at the extent of the trustee's obligation to revisit past transfers-out of the Lloyds schemes.
What are GMPs?
Before 6 April 2016, the state pension was made up of two elements: the basic state pension and the additional state pension. It was possible to contract-out of the additional state pension and, if a scheme did so on a salary-related basis before 6 April 1997, members accrued rights to a guaranteed minimum pension (or GMP).
The GMP is a minimum level of pension, calculated on a career average revalued earnings basis. Specific statutory requirements apply to GMPs for example, in relation to how they are calculated, revalued in deferment and increased once in payment.
Although GMPs stopped accruing in 1997 and contracting-out was abolished when the new state pension was introduced on 6 April 2016, members' accrued rights to GMPs remain protected and schemes must continue to meet the specific requirements that apply to GMPs.
Why are GMPs unequal between men and women?
GMPs are inherently unequal as between men and women for the following reasons:
> A woman's GMP accrues at a greater rate than that of a man in recognition that a woman's working life for state pension purposes was five years shorter than a man's. As a result, where a woman and a man have an identical work history, the woman's overall GMP will be greater than a man's.
> As a woman is entitled to receive her GMP at an earlier age (60) than a man (65), further differences can arise because of the revaluation and indexation provisions. Although the revaluation and indexation rates are the same for men and women, a woman will be entitled to indexation during periods when a man is entitled to revaluation.
> The requirement that GMPs are calculated and paid on an unequal basis flows through to an inequality in the overall scheme pension as a result of the anti-franking legislation (which essentially prevents schemes from offsetting GMP revaluation against the part of the member's pension which exceeds the GMP), and also because revaluation and indexation provided on the excess benefit is usually different to that on the GMP element.
Which sex is advantaged by this may change over the course of the member's retirement.
Which method for achieving GMP equalisation should schemes adopt?
There are two main methods for achieving GMP equalisation: the default method and GMP conversion (see box).
The cost of these two methods should be the same. However, the default method will require an ongoing year-by-year comparison, which is not required by GMP conversion. GMP conversion should therefore be less complicated (and less costly) to administer on an ongoing basis. In addition, GMP conversion has the advantage of removing GMP liabilities (and all the additional complexity they give rise to) once and for all. Many schemes may therefore prefer GMP conversion.
It is possible for the trustees and the employer to agree to an alternative method for GMP equalisation. For example, one option is for the scheme simply to pay the greater of the pension the member would receive under existing provisions and the pension they would receive had they been of the opposite sex on a year-by-year basis (this method was referred to in the Lloyds judgment as method B). If your scheme has no (or very few) members for whom the comparison switches from favouring one sex to the other, this should not have any significant cost implications and is likely to be far less administratively complex than the default method and easier to explain to members.
Trustees should also note that GMP conversion can only operate for the future. To calculate the back-payments due to members, the default method would need to be used.
The default method
The judge in Lloyds confirmed that the minimum required to achieve equality would be to carry out a year-by-year calculation of the pension the member would receive under existing provisions and the pension they would receive had they been of the opposite sex. The scheme must start by paying the greater of the two calculations. If the comparison later switches from favouring one sex to the other, the scheme must then pay the less generous amount, until the accumulated gains prior to the switch are equal to the accumulated losses after the switch. At this point the scheme must revert to paying the higher of the male and female benefit each year. Interest from the date of payment to the date of calculation is allowed for in the comparison of the values of accumulated gains prior to the switch and losses since the switch. This method was referred to in the Lloyds judgment as method C2 we refer to it as the default method, as this is the method trustees must adopt in the absence of employer agreement to an alternative method.
The judge in Lloyds also confirmed that the trustees and the employer could agree to convert GMPs to non-GMP benefits using the GMP conversion legislation. This involves comparing the actuarial value of the member's future unequalised benefits with the actuarial value of the future unequalised benefits that would apply to a member of the opposite sex and then providing benefits of equal actuarial value to the larger of the compared values (and which are the same for men and women).
Following GMP conversion, the requirements that apply to GMPs under legislation would no longer apply to the scheme.
The Lloyds judgment referred to this as method D2 we refer to it as GMP conversion.
Can trustees adopt different methods for different groups of members?
It is possible for trustees to adopt different GMP equalisation methods for different groups of members (eg the default method for existing pensioners and GMP conversion for deferred members). Provided one group is not being favoured compared to another in terms of the value they receive, this should not give rise to any discrimination issues.
It is also possible to implement GMP equalisation at different times for different groups of members (eg only implementing GMP equalisation for active and deferred members at the point their benefits come into payment). However, trustees may risk complaints if they knowingly provide members with information about their benefits in advance of those benefits coming into payment and then provide actual benefits which are different.
Trustees may also decide to bring some members into scope even if GMP equalisation does not apply to them. For example, GMP equalisation is not required for members who left service before 17 May 1990, but trustees may wish to include them in a GMP conversion exercise so that the restrictions applicable to GMPs no longer apply to these members. For any members included in a GMP conversion exercise, the whole of the member's benefit must be converted (ie not just the part relating to post-17 May 1990 accrual).
Are trustees obliged to make back-payments to members?
The judge in the Lloyds case concluded that:
> members are entitled to receive arrears of payments due to them;
> there is no relevant limitation period which applies under legislation; and
> the period for which members are entitled to receive arrears of payments may be limited by the scheme rules.
Trustees are therefore obliged to make back-payments to members, but they will need to consider whether their scheme rules put any limit on the obligation:
> If the scheme rules contain a six-year limit on payment of arrears, trustees will only need to make back-payments going back six years.
> If the scheme rules do not include any limit on payment of arrears, back-payments may need to be paid going back to 17 May 1990.
> If trustees have a discretion under the scheme rules, they will need to decide how they exercise that discretion (especially where members have died in the meantime).
This is likely to be a tricky area, as much will depend on the wording of the relevant scheme rules, as well as how the rules have changed over the years. Trustees will also need to consider the date from which the six-year limit should apply. In most cases, it will be appropriate to make back-payments going back six years from the date of the Lloyds judgment. However, we recommend speaking to your usual Linklaters contact before making any decision in this area.
Should interest be paid on back-payments?
The judge in Lloyds considered the interest which should be paid on back-payments. The judge indicated that if the base rate had been higher, he would have just said base rate should be paid. However, as base rate was low, he decided that simple interest of 1% over base rate should
be paid on back payments. We expect that most schemes will adopt this approach, although there may be scope for paying a different rate if back-payments are to be paid going back more than six years.
How should trustees deal with past transfers-out and other cases where no further benefits are due?
Given that a further hearing in the Lloyds case is expected to look at the extent of trustees' obligation to revisit past transfers-out, we recommend that trustees do not take any action in relation to transfer values already paid before the date of the Lloyds judgment for the time being. This includes transfers paid in respect of ex-spouses in divorce cases.
We also suggest that all other cases where the scheme paid a benefit before the date of the Lloyds judgment and no further benefits are due (eg serious ill-health commutation, trivial commutation and death benefit cases) should be treated in the same way as transfers-out for the time being.
This should not prevent trustees from progressing with GMP equalisation for other categories of members (including members who have been paid an unequalised transfer value or other benefit since the date of the Lloyds judgment).
What about cases where the members' options have been restricted in the past?
Members' options may have been restricted in the past to ensure the benefit paid at least covered the member's GMP at their GMP age (eg prohibiting early retirement on a reduced pension). We do not think trustees should worry about these cases, not least because the opportunity to offer different options has already gone. The member will not have lost any value in terms of their benefits under the scheme, so trustees can reasonably conclude that there is no need to pay any compensation. Even if a member were to claim some external loss arising from being underpaid, the trustees would probably not be liable: the underpayment would not be due to any fault on the part of the trustees but would be due to a mistake of law.
The position in relation to future cases is different: our view is that members should be given the same options they would be given had they been of the opposite sex.
Is it possible that schemes might have to reduce members' pensions in payment as a result of GMP equalisation?
Schemes which opt for GMP conversion are prevented from reducing pensions in payment by the legislation. But where schemes opt for the default method (or apply the default method prior to conversion) and pay arrears, it is possible that some members' pensions in payment will need to be reduced to reflect any arrears that can
be offset against future payments. This will happen in cases where GMP equalisation is implemented at a time when the comparison has switched from favouring one sex to the other, but the accumulated gains prior to the switch are not yet equal to the accumulated losses after the switch. At this point, the scheme must pay the less generous amount and part of the arrears will, in effect, be a pre-payment. Careful communication with members will be necessary in such cases.
How will GMP equalisation affect survivors' pensions?
Trustees should equalise survivors' pensions which include a survivor's GMP (or a "notional" GMP) using one or more of the GMP equalisation methods described above. One point to note is that survivors' pensions are often calculated by reference to the amount of the member's pension (eg a spouse's pension equal to 50% of the pension payable to the member at the date of death). If the member's pension would have been a different amount at the date of death had it been equalised, the survivor's pension will need to be adjusted to reflect that.
Can trustees adopt de minimis tolerance levels?
The government guidance on GMP conversion suggests that "trustees may wish to take advice in relation to members for whom the estimated cost of calculating and implementing equalisation is the same as or greater than the projected additional benefits to which the member
would be entitled as a result of equalisation". In our view, trustees' starting point should be that the member is legally entitled to equal benefits and the trustees are, strictly, obliged to provide them. The cost of equalising benefits (even if disproportionate) would not justify a failure to do so, although it might justify doing so on a "broad brush" basis.
If the extra benefits for members from equalisation are very small, the trustees might decide to wait for the member to make a claim before incurring the cost of implementing equalisation. However, trustees should keep in mind that even small amounts may be significant for some members.
What happens if trustees do not have the benefit records they need to implement GMP equalisation?
Trustees should take steps to ensure they have all the data necessary to equalise members' benefits correctly, even if there is a cost involved in doing so. If it is not possible to track down all the required data items (or the cost of doing so is disproportionate), trustees may need to make appropriate assumptions (usually following advice from the scheme actuary).
Can trustees use sex-based actuarial factors for GMP conversion?
The current legal position is that schemes can use sexbased factors. The key requirement for GMP conversion is that the converted benefits are equal for the member and their comparator. Whether this is achieved using sex-based or unisex factors does not matter, as long as the end result is equal benefits.
Having said that, our view is that there is a legal risk in using sex-based factors and trustees should generally be using unisex factors in all circumstances. Using unisex factors should also make the calculations required for GMP conversion simpler, as well as being easier for members to understand.
Can trustees use GMP conversion to reshape members' benefits?
Some commentators have suggested that trustees could use GMP conversion to remodel benefits in various ways (eg by changing the formula for increasing pensions in payment). However, the GMP conversion laws do not give the trustees complete freedom to change benefits in any way they want. They are limited to making changes which are desirable to facilitate GMP conversion. Trustees may risk challenge from members if they make changes that bear no relation to the requirements for GMP conversion. It would be better to make such changes only if they can be made by using the amendment power in the scheme rules and taking account of statutory limits on such powers.
When deciding the form of post-conversion benefits, trustees will need to exercise their discretion and the usual rules for exercising discretions will apply: the trustees must take into account all relevant factors, ignore irrelevant factors and avoid acting perversely. The relevant factors for trustees to consider will usually include the following:
> Members' expectations: members currently expect benefits in their current, pre-conversion form. They may object to any changes made without their agreement. For this reason, it will normally be desirable to make the fewest possible changes to benefits: the minimum required to equalise them and comply with statutory requirements. However, members could be offered options.
> Statutory requirements: the GMP conversion laws require post-conversion benefits to satisfy certain conditions; these may require changes to existing benefits. Other changes may also be required to satisfy the different laws that apply to GMPs and non-GMPs (eg the laws about revaluation of preserved pensions).
> Tax implications: changes to benefits may make members liable for an annual or lifetime allowance charge that they would not otherwise incur. Even worse from the member's point of view, they might cause loss of a lifetime allowance protection. This needs to be avoided.
> Funding and accounting implications: the differences in the actuarial assumptions used for different valuation purposes may mean that different benefits may be equal in value for some purposes but have different values for other purposes.
Is employer consent required for GMP conversion?
The legislation requires that the employer (or employers) in relation to the scheme must consent to GMP conversion in advance. It has been suggested by some commentators that consent might be needed from former employers who no longer participate in the scheme. Our view is that trustees only need to obtain the consent of former employers if they are still treated (under the scheme rules or legislation) as employers in relation to the scheme (eg for funding purposes).
If one employer in a multi-employer scheme has been nominated to act as the employers' representative "for all statutory purposes", that employer can give consent to the GMP conversion on behalf of all those employers.
Do trustees have to consult with members about GMP conversion?
The legislation requires trustees to take all reasonable steps to consult the "earner" in advance of GMP conversion. "Earner" includes anyone who has ever been contracted-out under the scheme. Strictly, it does not include a member who has never been an "active member" but who has a GMP under the scheme because of a transfer from another scheme (eg on a scheme merger), but we suggest trustees consult with such members anyway. Although the legislation is not clear on the point, we also think trustees should consult with pensioners and survivors whose pensions are subject to GMP conversion.
Although the consultation process to be followed is not specified in the legislation, we suggest that trustees and employers carry out a joint consultation which satisfies the requirements for a "listed change" (including a 60 day consultation period). In some cases, the GMP conversion process may involve a listed change so that the process required for a listed change will need to be followed in any event. But even if no listed change is involved, the listed change procedure sets a benchmark for what might be considered good practice when changing benefits.
Are there any notification requirements?
The trustees must take all reasonable steps to notify members and survivors whose benefits have been converted either before or as soon as practicable after the conversion date. This notice should tell members and survivors what the conversion means for their benefits.
Trustees must also notify HMRC on or before the conversion date that the member's or survivor's GMP has been or will be converted.
Are there any other formalities that must be completed to give effect to GMP conversion?
Scheme rules will need to be amended to reflect the changes to benefits that follow from GMP conversion. The legislation gives the trustees a statutory power to amend the scheme by resolution and we recommend using this power even if it is used alongside the scheme's own amendment power.
The actuary must send the trustees a certificate confirming that the post-conversion benefits are actuarially at least equivalent to the pre-conversion benefits.
What benefits need to be provided to survivors following GMP conversion?
The legislation contains detailed provisions about survivors' benefits following GMP conversion. Broadly speaking, most widows must be entitled to a pension of at least half the value of the pension to which the member would have been entitled by reference to employment between 6 April 1978 and 5 April 1997; for other survivors, the period is 6 April 1988 to 5 April 1997. The legislation also specifies when and for how long survivors' benefits must be paid.
For these purposes, "employment" is not limited to contracted-out employment. This may be an issue for schemes where survivors' benefits are currently less generous. Unless the employer agrees to bear any extra cost, the member's pension may have to be adjusted to provide a more generous survivor's pension.
The reference to half the "value" of the member's pension (instead of half the "annual rate" of the member's pension) may also require some changes to survivors' pensions following a member's early retirement. If the member's pension is reduced on early retirement, the reference to "value" suggests that the reduction should not affect the survivor's pension (ie the survivor's pension may have to
be more than half the member's pension if the member dies after retiring early). This is not necessarily a problem, but it may mean that early retirement reduction factors should be reviewed as part of the conversion process.
How should trustees deal with transferred-in benefits?
Whether trustees need to equalise transferred-in benefits will depend on the circumstances in which the transfer was made, and the information given to the transferring member about the benefits to be provided.
In the following cases, the receiving scheme should equalise the benefits granted to a member on transferring from another scheme where the benefits are unequal because of less favourable treatment under the transferring scheme:
> in the case of a transfer following a corporate transaction (eg the sale of an employer or business);
> if the transfer was made without the member's consent (eg on a merger of the transferring scheme into the receiving scheme);
> if the transfer was otherwise initiated by the employer (eg between schemes applicable to employment within the same group); or
> if the receiving scheme otherwise promised benefits equal to those the transferring scheme would have provided (eg on a transfer between two schemes applying to employment with the same employer).
In most cases of the kind mentioned above, members will have been told that their benefits will be the same as (or "no less favourable than") their benefits under the transferring scheme. As between the receiving trustees and the transferred-in member, it seems reasonable that the member should be able to rely on this promise. It may be that the receiving scheme then has a claim against the transferring scheme for failing to transfer sufficient assets to provide equalised benefits. However, that is a separate matter from the receiving scheme's liability to the member.
If, however, the member initiated the transfer and the transfer was not linked to a corporate transaction, the position will usually be different. The receiving scheme will usually have done no more than promise specified benefits for the member, in return for the specified transfer payment. In this kind of case, we see no need for the receiving scheme to provide more than it promised simply because the transfer value did not take account of all the member's rights under the transferring scheme. It will be the previous employer and the transferring scheme that discriminated against the member.
This assumes, however, that the receiving scheme has not itself treated men and women differently in calculating the benefits to be provided in return for the transfer payment. A receiving scheme will be liable for its own actions even if it does not "inherit" any liability for less favourable treatment of men or women under the transferring scheme. A receiving scheme is likely to have treated men and women differently when calculating the benefits to
be provided in return for a transfer payment that included an amount in respect of a member's rights to a GMP. This is because legislation will have required the receiving scheme to provide different amounts of GMP for men and women. The receiving scheme should now correct any differences in the benefits even if it has no liability to remedy discrimination by the transferring scheme. If the total benefits for a transferred-in member were based on the amount of the transfer payment, the receiving scheme should be able to remove any differences in the benefits for men and women without having to increase the value of the total benefits.
How should defined contribution (DC) schemes with a GMP underpin approach GMP equalisation?
In principle, the action that needs to be taken in relation to GMP underpin schemes to achieve GMP equalisation is the same as the action that needs to be taken by more typical defined benefit (DB) schemes. However, GMP conversion is likely to be even more attractive to these schemes as a means of removing the additional complexity associated with GMP liabilities (although trustees should note that the scheme will need to retain an equalised DB underpin following GMP conversion).
What about top-up schemes providing additional benefits to senior executives?
Some employers may have unregistered "top-up" schemes set up to provide benefits to senior executives which exceed those that can be provided under the main registered pension scheme. Such schemes do not typically include any contracted-out benefits, so GMP equalisation will not be generally be an issue. However, if a member's benefits have been increased under the main scheme as a result of GMP equalisation, it may be necessary to reduce the member's benefits under the top-up scheme so that they are not being overpaid.
The introduction of opposite sex civil partnerships
After years of campaigning to change the law, opposite sex couples are now able to become civil partners. Rebecca Steinfeld and Charles Keidan won their legal bid to enter into a civil partnership at the Supreme Court in 2018 after a five-year landmark legal battle. Following their victory, the couple entered into an opposite sex civil partnership on 31 December 2019, with Ms Steinfeld commenting that the civil partnership brings an end to the "unrivalled position of marriage" and "creates the space for deeper discussions about giving legal recognition to other types of personal and caring relationships".
Civil partnerships were first introduced by the Civil Partnership Act 2004 for same sex couples at a time when same sex marriage was not yet legal in the UK. From 2 December 2019, the 2004 Act has been amended to allow opposite sex couples to register civil partnerships in England and Wales. The first opposite sex civil partnerships were entered into on 31 December 2019, being the earliest date on which the unions could take place in the UK.
What does this mean for pension schemes?
In terms of what this means for UK pension schemes, opposite sex civil partners must be treated in the same way as same sex civil partners. To this end, scheme rules may need to be amended in some cases to ensure that death benefits can be paid to opposite sex civil partners. Generally speaking, such death benefits must also be the same as the death benefits provided to widows, widowers and same sex spouses.
Many schemes include a definition of "Civil Partner" which cross-refers to the definition of "Civil Partner" in the Civil Partnership Act 2004, without any reference to the same sex requirement in the definition or elsewhere in the rules. For those schemes, no amendments to the rules will be required as the regulations amend the definition of Civil Partner in the 2004 Act. However, rule amendments will need to be made where there are express references to same sex civil partnerships to ensure that death benefits can be paid to opposite sex civil partners.
In addition, it is likely that member communications such as scheme booklets will need to be updated to cater for the change. Trustees and employers may also wish to consider the funding impact of the introduction of opposite sex civil partnerships on their scheme.
A guide to deciding an ill-health early retirement application
Decisions about whether or not to pay an ill-health early retirement pension (sometimes called an incapacity pension) are not always straightforward.
There may be uncertainty about member eligibility or about when a member first qualified for a partial or total incapacity pension under the scheme rules. There can be conflicting medical information from a range of sources, or confusion about ongoing eligibility if a member's condition changes over time. There may also be complicating factors such as redundancy or deferment, which serve to confound the decisionmaking process.
This complexity means that decisions about incapacity pensions are often the subject of member complaints. In reviewing complaints, the Pensions Ombudsman will almost always focus on the process by which trustees reached a decision, rather than on the actual decision that was made.
In this article, we provide trustees with guidance on the process they should follow when considering a claim for an incapacity pension. While not exhaustive, the article provides information about the factors trustees should consider in their decision making. It focuses on the questions trustees should ask of the medical advisor and the actions that should be undertaken to reduce the likelihood of challenge or to defend a decision in the event that a member challenges the decision made.
"The test that we use is whether the people making the decision have gone about it in the right way and have made a decision that can be regarded as reasonable."
Does the scheme provide benefits for ill health early retirement?
Most defined benefit occupational pension schemes provide early retirement pensions for ill-health or incapacity. Tax legislation allows schemes to pay an illhealth early retirement pension as an authorised payment for tax purposes if a qualified medical practitioner confirms that the member is, and will continue to be, incapable of continuing their current occupation because of physical or mental impairment and the member has in fact ceased to carry on that occupation.
Many schemes incorporate the test under tax legislation into their scheme rules. But the criteria can vary across schemes with some imposing stricter incapacity criteria than legislation, such as requiring that the member be incapable of carrying out any occupation not just the occupation that they are in.
It is therefore important to confirm that your scheme provides benefits for ill health early retirement and to check the criteria that applies before starting to assess a member's application.
What information should be provided at the start of the application process?
The trustee should obtain:
> An employee consent form;
> A medical report from the member's GP setting out: diagnosis, history, treatment received and ongoing functional limitations;
> Specialist reports, where available; and
> An employer report on the functional requirements of the member's job.
Who decides whether the member qualifies for an incapacity pension?
The scheme rules should set out who has responsibility for the decision to pay an ill-health early retirement pension.
Payment of the pension is usually at the discretion of the trustee, but the decision can sometimes sit with the employer or require employer agreement.
Decisions relating to enhanced payment and pension review, both of which are discussed later, often need employer agreement.
Does the member qualify for an incapacity pension?
Assessing member eligibility for an ill-health early retirement pension can be tricky. The starting point is always the scheme rules. These must be correctly interpreted and applied by the trustee, as well as by the employer and medical advisors as applicable.
As the case study at the end of this article shows, it is important that trustees consider each application on its facts and do not fetter their discretion by rigidly applying a pre-agreed policy. The trustee must request and review appropriate evidence, deciding how much weight to give to each element bearing in mind the key principle that a decisionmaking process must take account of all relevant factors and disregard all irrelevant factors. Crucially, the trustee must ask the correct questions of the member and/or the medical advisor.
The opinion of the scheme's medical advisor is likely to be key. The trustees should ask the advisor to provide reasons for the recommendation made, especially if different to a specialist report. The medical advisor should have good knowledge of the scheme rules, providing details of how the member's condition will affect work performance, either now or in the future, to enable the trustees to decide whether the member is eligible for an incapacity pension. If the medical advisor is not providing relevant and comprehensive information, it is up to the trustees to question the advisor until all necessary information is obtained.
As noted earlier, in order for a member to be eligible for an incapacity pension, scheme rules often require that they must have ceased to carry on their occupation due to ill-health. In some cases, a member may cease to be employed for other reasons, such as redundancy or conduct-based termination, rather than because of illhealth. Trustees should therefore ensure there is a causal link between the member's incapacity and the member having ceased to be employed where this is required by the rules.
> Have the scheme rules been correctly interpreted and applied?
> Has appropriate medical evidence been received and reviewed?
> Does the medical evidence address the right questions?
> Have additional questions been asked of the medical advisor as needed?
> Is the decision supported by the available evidence?
If the member is deemed ineligible for ill health early retirement, the trustees should document their reasons and provide these to the member.
Providing reasons for a decision
The Pensions Ombudsman is of the view that members have a right to be given the reasons for a decision and that doing so aids good communication and transparency. Failure to provide adequate reasons has been found to give rise to maladministration.
Documented reasons should explain the weight placed on particular factors and why some factors have been discounted. They should help the member understand whether trustee or employer discretion has been exercised appropriately and whether there are grounds to challenge the decision.
Does the scheme provide for an enhanced pension?
Pensions taken before normal retirement date are typically reduced for early payment.
However, scheme rules may permit the trustee to pay an enhanced incapacity pension in cases where, for example, it is unlikely that the member will ever return to work. This usually means "scaling up" the member's pension to be the same as if the member's pensionable service included the period up to normal retirement date.
This decision often requires agreement between the trustee and the employer.
Should the decision to pay an incapacity pension be reviewed in future years?
Scheme rules may provide that a pension paid on incapacity grounds may be reduced or stopped if the member's physical or mental condition improves and the requirements for paying an incapacity pension are no longer satisfied.
The trustees should expect the medical advisor to provide a recommendation regarding the need for, and frequency of, review of the member's condition to assess ongoing eligibility for the ill health pension.
In such cases, trustees should make it clear when communicating a decision to the member that the pension will be reviewed, noting the frequency of the review and the fact that the pension may be stopped or changed.
Decisions relating to ill-health early retirement can be complex, requiring trustees to review a range of information within the framework of the scheme rules.
It is important that trustees adopt a systematic and thorough approach: considering each case on its facts; giving careful consideration to the requirements of the scheme rules; asking the right questions to make sure there is sufficient information on which to base a decision; and documenting the reasons for the decisions made regarding eligibility, enhancement and review.
Deciding ill-health early retirement in practice
In a recent Pensions Ombudsman decision (Mr S v Trustees of the Sears Retail Pension Scheme), the Ombudsman directed the trustees to review their ill-health retirement decision.
Mr S became a deferred member of the Sears Retail Pension Scheme (Sears Scheme) in 1983 and retired on the grounds of ill health in 2008. In 2003, Mr S had enquired about taking his pension early for reasons of ill health. He was informed by the trustees of the Sears Scheme (the Trustees) that it was not possible to draw the pension early since the reduction for early payment that was required under the Sears Scheme rules would take Mr S's pension below the guaranteed minimum pension that must be paid at normal pension age (NPA).
In 2014, Mr S again made enquiries about taking his pension early and was advised that this option was available to deferred members, but the pension could not be paid if it was less than the GMP that would be payable at Mr S's NPA.
Following the 2014 response, Mr S submitted medical reports from 2007 seeking ill health early retirement from that time. Mr S stated that he had not applied earlier because the 2003 advice he had received was that it was not possible for him to seek early payment.
Following this, Mr S was informed that early retirement from 2007 could be granted on a reduced basis, but the amount of reduction would take Mr S's pension below the GMP and could not therefore be paid. The trustees explained that Mr S's condition was assessed as "Grade 3 medical incapacity". Payment of early pensions on an unreduced basis must be assessed as "Grade 5" meaning total incapacity or very limited life expectancy.
The relevant Sears Scheme rules defined "serious ill health" as that which "prevents (and will continue to prevent) the member following his or her normal employment". The rules also noted that decisions relating to member ill health were at the trustees' discretion, subject to receiving appropriate medical evidence, and that early payment due to ill health involved a reduction unless the trustees decide otherwise.
The Ombudsman upheld Mr S's complaint and emphasised that the trustees should not fetter their discretion in any way. While the Ombudsman regarded the grading system used as helpful for maintaining consistency and fairness, its rigid application could equate to maladministration in limiting the trustees' ability to exercise independent judgment and consider each case on its facts. The Ombudsman concluded that this was the case here and directed that the trustees reconsider the decision not to waive the early payment reduction from 2007.
This case is a useful reminder to trustees that, in exercising a discretion under scheme rules, they should be careful to apply independent judgment based on the facts of the case and should not rigidly or formulaically apply pre-agreed policy.
DB to DC transfers: the requirement to obtain appropriate independent advice
Since 2015, trustees have been required to check that members have received appropriate independent advice before transferring their benefits from a defined benefit (DB) scheme to a defined contribution (DC) scheme. The requirement applies to all such transfers unless the transfer value is 30,000 or less.
The Pensions Regulator recently updated its guidance on DB to DC transfers. The updates were made to reflect changes to the FCA's Financial Services Register, but they appeared to introduce an additional step for trustees to complete: as well as checking that the company or business providing the advice has permission to carry on the regulated activity, the Regulator said that trustees should also check that the relevant individual works for that firm.
The Regulator has since amended its guidance again to say that trustees can undertake this additional check. However, trustees may wish to add this step to their existing processes as a matter of good practice.
What are trustees' obligations regarding the advice requirement?
Trustees don't need to check what advice was given, what recommendation was made or whether the member is following that recommendation. But they do need to check that the advice has been received. The member should provide to the trustees written confirmation from their adviser, confirming:
> that advice has been provided which is specific to the type of transaction proposed by the member;
> that the adviser has permission to carry on the regulated activity;
> the firm reference number of the company or business in which the adviser works; and
> the member's name, and the name of the scheme in which the member has db benefits to which the advice given applies.
Trustees need to check for themselves that the company or business providing the advice has permission to carry on the regulated activity by checking the Financial Services Register maintained by the FCA.
What does the Regulator's guidance say?
Although not strictly required by the legislation, the Regulator updated its guidance in November last year to say that trustees should then check that the relevant individual works for that firm. Following the introduction of the FCA's Senior Managers and Certification Regime in December 2019, only individuals performing senior management roles are included in the Financial Services Register. To address this information gap, the FCA is going to create a new Directory, which will include details of certified persons.
Until then, the Regulator said trustees need to contact firms to confirm that the relevant individual works for that firm or check an appropriate third-party directory (although it isn't clear what third-party directories the Regulator has in mind).
The Regulator has since amended its guidance again to say that trustees can undertake this additional check, presumably in recognition that this step is not required by the legislation.
The Regulator adds that trustees should:
> Keep a copy of the adviser's written confirmation, together with a record of who conducted the check, when this was conducted and evidence that the adviser's firm or company was on the Financial Services Register before the transfer of benefits was made. These records should be retained for at least 6 years.
> Be alert to the risk of fraudulent communications submitted to the scheme confirming appropriate independent advice has been provided when this has not been the case.
> Contact the member as soon as possible if there is a problem corroborating information on the Financial Services Register and explain that the transfer won't proceed until the member has provided the correct information.
Is any action required?
Trustees need to make sure they are carrying out the checks required by the legislation. If they fail to do so, they may be liable to a civil penalty of up to 5,000 for individuals or 50,000 in the case of a corporate trustee. Trustees will not be in breach of the legal requirements if they fail to carry out the additional checks recommended in the Regulator's guidance. But carrying out these checks would be best practice and should provide some protection in the event of member claims.
On the horizon
Subject Pension Schemes Bill
HMRC preferential status Budget 2020 Investment
The Pension Schemes Bill has been re-introduced in much the same form as before the election. The Bill covers the following key areas: > strengthening the pensions regulator's powers; > changes to the scheme funding regime; > changes to the legislation governing cash equivalent transfer values; > providing a framework for pensions dashboards; and > providing a framework for collective defined contribution (cdc) schemes.
The government has published draft legislation which will make HM Revenue and Customs a secondary preferential creditor for taxes paid by employees and customers. The significance of the change is that there will be less available for ordinary unsecured creditors (including pension schemes).
The Conservative manifesto included proposals in relation to the annual allowance taper and the net pay issue, so we might see these included in the Budget.
Regulations require trustees to set out their policy on arrangements with asset managers and their policies in relation to capital structure, conflicts of interest and other stakeholders. New reporting and disclosure obligations also apply.
Next key date
The Bill will now progress through Parliament. The next stage (Committee stage, which involves a line by line examination of the Bill) is scheduled to take place from 24 February to 4 March 2020.
This change is expected to be included in the next Finance Bill.
Budget 2020 will take place on 11 March.
The requirements apply from 1 October 2020.
Investment consultants and fiduciary managers
A Competition and Markets Authority Order requires trustees to carry out a tender process for fiduciary management services and set objectives for their investment consultants. The government has consulted on draft regulations which aim to integrate the CMA Order into pensions law. The Regulator has also published guidance for trustees on engaging with investment consultants and fiduciary managers.
The government has said it intends to amend the Equality Act 2010 to remove the requirement for a comparator "as soon as a suitable opportunity presents itself". The government has also said it is considering changes to the GMP conversion legislation "to clarify certain issues". HMRC has published guidance on GMP equalisation, covering pensions tax issues relating to the annual allowance and the lifetime allowance.
The requirements apply from 10 December 2019.
The consultation on the draft regulations closed on 2 September 2019 and the government said it was aiming for a coming into force date of 6 April 2020.
HMRC says it is continuing to explore the pensions tax issues not covered in the guidance, including the treatment of lump sum and death benefit payments, and it is aiming to give more guidance on these "as soon as possible". HMRC is also continuing to explore the tax implications for schemes choosing GMP conversion. HMRC is also continuing to explore the tax implications for schemes choosing GMP conversion.
Opposite sex civil partnerships Defined benefit (DB) consolidation/ superfunds
Defined contribution (DC) scheme investment and consolidation
Opposite sex couples are now able to become civil partners. Scheme rules may need to be amended in some cases to ensure death benefits can be paid to opposite sex civil partners.
The government has consulted on a new legislative framework for the regulation of DB "superfund" consolidation schemes.
The government has responded to its consultation on changes to the Pensions Ombudsman's processes and jurisdiction. This confirmed that an early resolution function within the Ombudsman's remit would be introduced.
The government has consulted on proposals which aim to encourage DC schemes to consider a wider range of investments. The proposals included a requirement for larger DC schemes to explain their policy in relation to investment in illiquid assets in their statement of investment principles and for smaller DC schemes to explain their assessment of whether it would be in members' interests to be transferred into another scheme with significantly more scale.
The legislation came into force on 2 December 2019.
The consultation closed on 1 February 2019. A response is awaited.
The government said it would seek to bring forward legislation to provide for a framework for the proposals "in due course", but this has not been included in the Pension Schemes Bill and it is unclear when it will be forthcoming.
The consultation closed on 1 April 2019. A response is awaited.
Annual benefit statements
Future of trusteeship and governance
Single code of practice
The government has consulted on proposed changes to the rate of the general levy payable by occupational and personal pension schemes from April 2020.
The consultation closed on 29 November 2019. A response is awaited.
The government has consulted on its proposed approach to achieving simpler annual benefit statements for workplace pensions.
The consultation closed on 20 December 2019. A response is awaited.
Two Regulator consultations on scheme funding are expected: the first consultation will focus on options for a clearer framework for DB funding. The second consultation will be on a draft code of practice.
The Regulator has published its response to last year's consultation on the future of trusteeship and governance. Many of the more controversial proposals, such as requiring a professional trustee to sit on every pension scheme board, have been shelved. But trustees can expect some changes, particularly in relation to trustee knowledge and understanding (TKU).
The Regulator has said it is planning to combine the content of its 15 current codes of practice to form a single, shorter code. Its intention is to develop the new code in phases, with its early focus being on the codes most affected by the regulations that implement the EU pensions directive (known as IORP II). These include the codes of practice on internal controls, DC schemes and master trusts.
The first consultation is expected in March, while the second consultation is expected later in 2020.
The Regulator plans to consult on a revised TKU code of practice in early 2021.
A consultation is expected this year.
UK Stewardship Code Professional trustee standards
The Pension Protection Fund has published its final levy rules for the levy year 2020/21. The PPF has also published a consultation on proposed changes to insolvency risk services from 2021/22, when Experian will be replaced by D&B.
The Financial Reporting Council has published its revised Stewardship Code, which sets out more rigorous reporting requirements and higher expectations for investor stewardship policy and practice.
The Association of Professional Pension Trustees has published standards for professional trustees of occupational pension schemes. The standards apply to anyone falling within the Regulator's description of a professional trustee. A two-part accreditation framework will assess professional trustees on their initial application and then monitor continued compliance on an annual basis.
The deadlines for schemes and employers to take steps to reduce their PPF levy vary, but 31 March 2020 is the relevant deadline for most steps.
Two further consultations will be published in mid2020 and autumn 2020, covering the levy framework and the draft levy rules for 2021/22 respectively.
The new code took effect on 1 January 2020, with the first disclosures due in 2021.
The accreditation process will be overseen by the Pensions Management Institute and is expected to commence this year.
Money laundering Future of RPI
HMRC has published a consultation on proposals to expand the Trust Registration Service (TRS) to comply with the Fifth Money Laundering Directive. Helpfully, the consultation proposes that registered pension schemes will continue to be out of scope and will not be required to be registered on the TRS.
The consultation closes on 21 February 2020.
The government has said it intends to consult on whether RPI should be aligned with CPIH before 2030 (when the Chancellor's consent to this change will no longer be required), and if so, when between 2025 and 2030.
The consultation is expected to launch at the Budget on 11 March. It is expected to be open for responses for a period of six weeks, closing on 22 April. The government and UKSA are intending to respond to the consultation before the Parliamentary summer recess.
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