A rising number of equalisation issues are coming to light, which need urgent attention.
We are seeing an increasing number of cases involving the failure of defined benefit schemes to have equalised their pension benefits properly or, where the scheme rules do provide for effective equalisation, this has not been implemented correctly in practice by administrators and, in some cases, announcements to members about equalisation are potentially misleading members as to their benefit entitlements.
The outcome is potential liability which, depending upon the circumstances of the particular equalisation issue, may fall on trustees, administrators, employers and/or professional advisers. This in turn can give rise to expensive litigation (usually by alleging negligence), consideration of any indemnity insurance and damage the relationships between the parties.
It is important to identify potential equalisation issues as quickly as possible for two key reasons. Firstly to take immediate steps to ensure that the scheme is effectively equalised in order to limit the extent of any future liability. Secondly, to ensure that a claim may be brought in respect of any liability that has already arisen; the law imposes a complex range of time limits on bringing a claim (often calculated from the point in time when you should have been aware of the issue) and so it is important to identify and, with your lawyer, take appropriate procedural steps (even if not bringing a claim straight away) to protect your ability to bring a claim in the future.
So what is equalisation?
Historically many defined benefit occupational pension schemes had different retiring ages based on gender (usually aged 60 for women and aged 65 for men), the effect usually being to discriminate unfairly against men in calculating their pension benefits. On 17 May 1990 the European Court of Justice decided in the case of Barber that this unequal treatment had to be removed but thought that it would be unfair to require schemes (and the underlying employers) to meet the costs of doing so retrospectively. Therefore, the Court decided:
- the period up to 17 May 1990, no equalisation is required;
- the period from 17 May 1990 to the date when scheme benefits are equalised (ie, the rules of the scheme are effectively amended to ensure that men and women are treated the same), when benefits must be "levelled up" (i.e. increased to the level enjoyed by the advantaged sex); and
- the period after the date when the scheme benefits is equalised. In theory this could involve the benefits being "levelled up" (as described above) or "levelled down" (ie, the advantaged sex's benefits are reduced to the level enjoyed by the disadvantaged sex) although any proposal to "level down" should be considered carefully to make sure the terms of the scheme's amendment power and section 67 of the Pensions Act 1995 (restrictions on the power to make retrospective amendments on or after 6 April 1997) have been complied with.
Many schemes with unequal normal retirement ages based on gender awaited the outcome of Barber and some further cases before taking any action so will at least have a small period from 17 May 1990 to the date when equalisation was implemented when benefits are “levelled up”. However, when schemes did purport to equalise, many did so just by issuing announcements to scheme members stating that equalisation had occurred. Others sought to equalise by amending their scheme’s rules pursuant to its power of amendment (whether that involved an amendment by deed or otherwise). To be effective, it is important that the latter approach was adopted and then implemented in practice by scheme administrators.
Why is equalisation causing concern now?
The concern over rising defined benefit scheme deficits, looking for ways to manage this and, in the case of buyers in a transaction, not wanting to become saddled with an unexpected liability, are leading to greater scrutiny of how the schemes have been managed. This in turn brings equalisation to the fore. Furthermore, when scheme advisers or administrators change (or when members are unhappy with the level of their benefits, which may be lower than they expected), such issues tend to come out.
An equalisation example
On a change of a scheme administrator questions were raised by the new administrators about the methodology used for calculating early retirement pensions and, in particular, the interplay between early retirement factors and equalisation. This led to a review of the scheme's rules, trustee minutes and various communications with the employer members and professional advisers. It was discovered that steps had been taken to equalise the scheme on several occasions although it became apparent that not only were purported amendments to the scheme's rules to effect the equalisation invalid because they breached the provisions of the scheme's amendment power as well as being void for infringing section 67 of the Pensions Act 1995, but that the trustees and the former scheme administrators had both misunderstood (and interpreted differently) how the equalisation mechanics worked, in some cases passing on that misunderstanding to members by way of member communications.
The overall effect is that there are potential claims by members and benefits have still not properly been equalised under the scheme and so the benefits are treated as being "levelled up" increasing the costs to the scheme, even though the trustees thought this issue had been dealt with some time ago. This has resulted in an estimated liability of £12 million and litigation is being considered against both the scheme's former administrators and the professional advisers.
How can you spot potential equalisation issues in your scheme?
- if your scheme's rules currently have different normal retiring ages for men and women, it is likely to be discriminatory and equalisation should be considered.
- if your scheme's rules used to provide different normal retiring ages based on gender but now the scheme's rules provide for all members to retire at the same age regardless of gender, you should ask yourself:
- is there a gap in time between 17 May 1990 and the date when the scheme rules were amended? (If yes, there will at least be a period of “levelling up” of benefits for this period);
- how were the scheme’s rules amended (i.e. did this comply with all the requirements of the scheme’s amendment powers and is there any indication that section 67 of the Pensions Act 1995 was considered/complied with (for example a section 67 certificate issued by the scheme actuary))?
- how was the rule change communicated to members and does that communication accurately summarise the rule change?
- is there any evidence that the administrators were informed and acknowledged the rule change and that they apply pension benefits on that basis?
- many schemes have purported to equalise by way of member announcement (and no formal amendment to the scheme’s rules) and it is increasingly doubtful this will be effective. If your scheme appears to have equalised in this way, seek legal advice as to the effectiveness of the announcement in equalising the scheme.
- check trustee minutes of the time and any correspondence between employer, trustees, advisers and members since this may help explain the manner in which the scheme purportedly equalised its benefits.
- where equalisation has been implemented under the scheme's rules, how do administrators apply this in practice today both in terms of how they communicate this to members and the calculation/payment of benefits?
- if your scheme has received a transfer-in from another scheme, then you should question whether that scheme's benefits were equalised before transfer. If not, this is a potential liability that your scheme will need to correct.
- if your scheme is about to receive a transfer-in from another scheme as part of a scheme merger, ask your advisers to confirm that they have checked that other scheme has already equalised its benefits.
Above all, if you have any doubts as to whether your scheme has been properly equalised then it is advisable to seek legal advice as soon as possible.
Are there any other lessons to learn from this?
Yes – Trustees need to ensure that:
- issues arising in respect of the scheme and what is being done about them are properly minuted;
- before effecting any amendment to the scheme’s rules, they understand what those amendments do and have an adequate explanation from their advisers (ideally in writing);
- they have on record formal notification of any rule amendments to the scheme administrators, actuary and scheme accountant (ideally with acknowledged receipt); and
- procedures are put in place, with appropriate all-adviser input, to check on a regular basis whether the scheme is indeed being administered in accordance with its rules.