The High Court has handed down an important judgment on equalisation of guaranteed minimum pensions (GMPs) in Lloyds Banking Group Pensions Trustees Limited v Lloyds Bank plc and others (Lloyds).
The pensions industry now faces the cost and complexity of grasping one of its fiercest nettles - how to implement the equalisation of GMPs in practice.
Our experts have distilled this lengthy judgment and bring you a key point summary, a plain English explanation of the issues and suggestions on next steps for employers and trustees.
For anyone who is not immersed in how GMPs work or who would like a refresher on why they create equalisation issues, we have also put together a separate guide to the basics.
The High Court has handed down an important judgment on equalisation of guaranteed minimum pensions (GMPs) in Lloyds Banking Group Pensions Trustees Limited v Lloyds Bank plc and others (Lloyds). The pensions industry now faces the cost and complexity of grasping one of its fiercest nettles - how to implement the equalisation of GMPs in practice. Our experts have distilled this lengthy judgment and bring you a key point summary, a plain English explanation of the issues and suggestions on next steps for employers and trustees.
For anyone who is not immersed in how GMPs work or who would like a refresher on why they create equalisation issues, we have also put together a separate guide to the basics.
Seven key points from Lloyds
1. Trustees have a duty to equalise GMPs
Trustees of pension schemes with GMPs are under a legal duty to adjust benefits to address the current inequality between men and women which is inherent in the GMP.
2. Methods to equalise - various methods are lawful, but some are not
There is more than one method of adjustment that is permissible, although there are some that are not permissible. Schemes and employers will need legal and actuarial advice in order to decide what method should be adopted.
3. Arrears will need to be paid with interest
For pensions that are already in payment, arrears need to be paid, with interest, to make good the past underpayments.
4. Forfeiture clauses may limit the duty to pay arrears
No statutory limitation period applies to such arrears, but forfeiture clauses in scheme rules may limit the duty to pay arrears. This will vary from scheme to scheme and bespoke legal advice will be needed.
5. The forfeiture point has a wider application to underpayments generally
The point on forfeiture clauses limiting the duty to pay arrears has relevance to underpayments generally: it extends beyond the issue of GMP equalisation.
6. Certain legal issues remain unresolved
Certain legal issues remain unresolved following Lloyds. In particular, there remains the questions of what duties trustees have in respect of GMPs that accrued in their schemes but have been transferred out and whether a different method can be adopted where the costs of implementing one of the methods considered is greater than the additional benefits that would be conferred as a result.
7. Employers and trustees face practical issues in implementing equalisation
Whilst Lloyds has removed some of the legal uncertainty, it leaves a number of practical issues for employers and trustees to consider. These include the quality of member data, dealing with death cases, the impact on cash equivalent transfer value (CETV) calculations and ongoing valuation discussions.
In this Insight, we set out:
What Lloyds decided on the need to equalise GMPs
The Lloyds decision is clear that trustees of schemes with GMPs have a legal duty to equalise the benefits provided by the scheme, to remove the inequality deriving from the GMP.
This stems from the European law principle of equal pay for equal work, which has also been adopted into UK legislation. Because GMPs are paid by occupational pension schemes, they are a reward for work and therefore there is a duty to pay them on an equal basis between men and women.
However, this duty only arises in respect of GMPs accrued since 17 May 1990. This is the date from which European law requires employment-based pension benefits to accrue on an equal basis for men and women. Identifying what portion of the GMP can be said to derive from post-17 May 1990 service is another practical difficulty when it comes to equalising them.
That there is a duty to equalise GMPs is unlikely to surprise those involved in the pensions industry. Pre-Lloyds, there were tenable arguments that GMP equalisation was not legally necessary, albeit few thought they would succeed in court. The best of these arguments was that GMPs were intended to mirror a social security benefit, i.e. SERPS. Social security benefits are not caught by the equal pay rule (the government is under no obligation to equalise the effects of SERPS) so it is illogical to treat GMPs more favourably. That argument was rejected in Lloyds.
The main reasons why schemes have been putting off equalising GMPs is doubt over the correct method to equalise them and the practical difficulties of calculating and administering equalisation. Schemes that have been wound up and bought out with an insurance company do usually equalise GMPs at that time.
There are some pension schemes that have only ever had members of one sex. For such schemes, the issues are different, and beyond the scope of this note.
What did Lloyds say about how to equalise GMPs?
Methods for equalising GMPs
The most significant aspect of Lloyds is the guidance it gives in determining how to equalise GMPs. The case concluded that there is more than one possible method, despite arguments by the members that only one method was permissible.
Lloyds was also clear that trustees do not have a free hand over what method to adopt. They are constrained by the extent of their duty and the principle of "minimum interference" to the rights of either party, which we will discuss further below.
The case does however set out some useful principles which will apply to the majority of schemes.
The fact that there are now methods that have clear court approval will make the decision much safer for schemes than was the case before.
There are four broad families of methods for equalising GMPs, which (following the terminology in Lloyds) are labelled Methods A to D. They can be broadly described as follows. For most schemes, the following order is a decreasing order of cost.
- Method A - the element-by-element method (several varieties of this were considered in Lloyds);
- Method B - the compare and increase method;
- Method C - the equal payments method (two varieties of this are considered in Lloyds and were distinguished as C1 and C2); and
- Method D - the actuarial equivalence method (two varieties of this are considered in Lloyds and were distinguished as D1 and D2).
The court in Lloyds did not consider any other methods, but acknowledged the possibility that other methods may exist.
All the methods require a comparison between each member's benefit and the benefit payable in respect of a notional comparator of the opposite sex with identical date of birth, service and earnings history. In order to illustrate the various methods, this Insight uses a hypothetical man (M) and a hypothetical woman (F), to represent the member and the notional comparator.
Often, but not necessarily, a woman's pension will be higher than a comparable man's in the early years of the pension, because she benefits from the effect on the calculation of the shorter "working life" and more generous revaluation in deferment. Over time, however, she increasingly suffers from the fact that once in payment the GMP is not increased as generously as the excess, and there may come a crossover point where the man's pension becomes more generous.
This does not always happen (it depends on the circumstances) but we will assume it is the case in respect of M and F.
Method A - the element-by-element method
This Insight does not need to go into detail on the various Method A calculations as they were ruled out in Lloyds, but they broadly involve taking the various elements of pension separately and comparing them, and then putting together a composite benefit taking into account the most favourable treatment of each element. This is the method that the members in Lloyds (through the representative beneficiaries) were arguing for.
Method B - the compare and increase method
Method B is the method that was first proposed as a possible solution by the Department for Work and Pensions (DWP) in 2012. It involves, when the pension comes into payment, calculating the pension due to M and F, and paying whichever is the higher. Every time the pension is increased thereafter, a similar comparison is carried out and the higher benefit is always paid.
So for such a member, Method B would uplift M's pension to F's level in the early years, and uplift F's pension to M's level after the crossover point.
This means that using Method B to equalise their GMPs would result in both M and F getting more pension overall than would be the case if their GMPs were not equalised. That arguably over-compensates them, as the concept of equalisation simply requires the disadvantaged sex to be uplifted to the level of the advantaged sex.
Method C - the equal payments method
Method C attempts to deal with that problem. On this method, M's pension is uplifted to F's level at the start. However, once the crossover point occurs after which M's level would be higher, F's level continues to be paid in respect of both M and F.
This is justified on the grounds that F, pre-equalisation, was only entitled to be paid that level of pension anyway, and although M, pre-equalisation, would have been entitled to more, the duty to pay him more can be said to have been satisfied by the uplifts he received on earlier instalments.
Only once the total value of those uplifts has been used up does the pension switch to be paid at M's level.
Under this method, both M and F are paid the same amount at all times, and the aggregate amount that has been paid to them at any time during their retirement is no greater than the aggregate amount that would have been paid to the more favoured sex prior to equalisation.
Academically, this is perhaps the most logical method, but it is also incredibly complex (and therefore expensive) to implement and then administer. The practical challenges of implementing it are likely to limit its appeal.
Method D - the actuarial equivalence method
Method D is the method that has been adopted on most wind-ups in our experience. It involves making an actuarial calculation of the capital value of M's pension and F's pension. The difference in the capital value is then actuarially converted back into an additional element of pension, which is added onto the pension of whoever's capital value was the lower.
The considerable advantage of this method is that once the initial actuarial calculations have been carried out, there is no further work to do - the uplifted pension simply carries on being paid and increased in the normal manner. There is no administrative complexity at each pension increase, unlike the other methods.
However, because it involves reliance on actuarial assumptions, it is not as precise as the other methods. Actuarial assumptions by their nature will not accord with the reality, so there is an inbuilt error in this method.
The Methods favoured in Lloyds - Methods C2 and D2
The judge in Lloyds applied the principle that when deciding how to equalise benefits between men and women, "minimum interference" should be made to the rights of either party. A method that is excessively generous infringes the rights of the employers; a method that is insufficiently generous infringes the rights of the members. As a result:
- Method A was ruled out, on the grounds that it involved more than minimum interference to the rights of the employer.
- Method B was permissible, but the employer could require trustees not to use this method.
- Method C was permissible, and the employer could require the trustees to use one variant on it (Method C2).
- Method D was permissible but only if the GMP was converted into a non-GMP benefit as part of the process (called Method D2). Otherwise, it offended against the principle of minimum interference to the rights the members.
Method C2 follows the "Method C" description above but takes into account the time value of money, by adding a notional amount of interest when determining how much a member has been paid at any point in time. This makes it somewhat less generous to members than the other variant of Method C (Method C1), which does not make any adjustment for the time value of money.
Method D was ruled out because the use of actuarial assumptions goes against the interests of the beneficiaries. However, a variant on it, Method D2, was permitted.
Method D2 involves taking the GMP out of the benefit altogether, which is already possible under existing legislation known as the GMP conversion legislation. Under the GMP conversion legislation, the converted benefit must be of no less actuarial value than the value of the benefit including the GMP. In order to use Method D2, however, employer consent is required.
Because the GMP is required to be equalised, when carrying out that actuarial comparison, it is necessary to value the equalised GMP.
Using this legislation makes Method D possible, because there is already statutory authority for using an actuarial value test to convert GMPs into non-GMP benefits. If this process is being carried out, all that needs to be done is to make an actuarial assessment of the value of the equalised GMP, and the effect is to equalise the GMP via actuarial assumptions, which would not be permissible otherwise.
The method the Government consulted on in 2016, its second consultation on a possible method for equalising GMPs, is based on Method D2.
Our initial view is that this method is likely to find the most favour with both trustees and employers, although some schemes may have reasons to select a different method. The need to convert the GMP into a non-GMP benefit adds a layer of complexity over the variant of Method D that does not include this, and schemes will need legal advice as well as actuarial advice on the steps required for this.
For a pension that is already in payment, there is a duty to pay arrears in respect of the past instalments of pension which were paid on an unequalised basis. Interest must also be paid on the arrears.
Lloyds contains useful instruction to trustees when it comes to paying arrears. The relevance of this extends beyond the GMP equalisation issue, as it could also apply to any situation where benefits are found to have been previously underpaid.
The key points of Lloyds in relation to arrears are as follows.
- In current market conditions, 1% over base rate is the appropriate interest rate to pay. This can be calculated using simple rather than compound interest.
- The appropriate interest rate may change: the judge noted that 0% over base rate would be acceptable if base rate were higher (but there does not appear to be any clear basis for determining this).
- No statutory limitation period applies when paying members arrears of pension.
- However, if the scheme rules contain a forfeiture clause, that may limit the time period in respect of which arrears are payable. Whether or not that is the case depends on the construction of the forfeiture clause in the particular scheme.
Some forfeiture clauses give Trustees a discretion on whether to pay older benefits or treat them as forfeit. There is little in Lloyds by way of useful guidance as to how Trustees should exercise that discretion in an underpayments situation. Scheme-specific legal advice will therefore be particularly important for schemes with such rules.
What areas are still uncertain after Lloyds?
Does Lloyds answer all the questions about GMP equalisation?
With a subject as complex as this, that was always going to be a challenge. In particular, one important question that has been put off for another day is what duties trustees have in respect of GMPs that accrued in their schemes but have been transferred out.
The case also raised - but did not answer - the question of whether a different method can be adopted where the costs of implementing one of the methods considered is greater than the additional benefits that would be conferred as a result.
Lloyds has provided a clear judicial ruling on many of the issues relating to GMP equalisation. It also focuses consideration on the practical issues relating to how schemes calculate, administer and pay equalised GMPs.
What are the practical issues in implementing GMP equalisation?
Although Lloyds answers the big questions about whether and how to equalise GMPs, there will still be challenges in respect of a number of points of detail.
Examples of practical challenges that many trustees are likely to face include the following:
- quality of member data - this is likely to be a key issue for trustees, scheme actuaries and administrators looking to implement equalisation.
- members who no longer have an interest in the scheme - is there any duty to pay arrears in respect of a member who has died, transferred out or fully commuted his benefits?
- calculation/suspension of CETVs - what should trustees do now if a member requests a transfer value, before the work has been done to decide how Lloyds affects the scheme?
- ongoing valuation discussions with employers - how will Lloyds impact on current valuation discussions? How should GMP equalisation be reflected in the period until an approach to equalisation has been agreed?
Our pensions experts can help trustees in ensuring that the decisions they make on the above points are as safe as it is possible to be, as the position evolves.
Might the position change again?
Although at the time of writing there is no indication that Lloyds Bank will appeal this decision, the possibility of further litigation on this question cannot be ruled out. The position could change again.
If Parliament is in a position to deviate from European law post-Brexit, it could legislate for an exception to the general rule on equal pay for equal work in order to permit GMPs to remain unequalised. This could be justified on the grounds that GMPs are a legacy from a previous age, they are not still accruing, and the benefits of undoing their discriminatory effect (which for many pension scheme members will be marginal) are arguably outweighed by the cost and complexity of equalising them. There has been no indication that the Government is considering such legislation, however.
The DWP has said that it now intends to provide guidance for pension schemes on the topic.
What actions do trustees and employers need to consider following Lloyds?
Trustees and employers will now have to consider their next steps in respect of GMP equalisation.
- Trustees may want to schedule time at the next trustee meeting to discuss how Lloyds affects them. This could include input from the scheme's professional advisers.
- Trustees of schemes with GMPs will need specific legal advice on the nature and extent of their duties arising from Lloyds. They will also need actuarial advice to inform the decision as to what method to adopt.
- Sponsoring employers also have a role in this, given that they ultimately fund the increased liabilities and the cost of doing the work. They should therefore be part of the conversation and may want to take their own independent legal and actuarial advice.
- Trustees will need to take legal advice and make a decision on the extent of the duty to pay arrears and whether this is limited by any forfeiture clause in the scheme rules.
- Scheme administrators will then have to do the necessary calculations.
The issues thrown up by the Lloyds case are complicated and the potential costs are significant. Our pensions experts are ready to discuss how they affect you and your pension scheme.