The High Court has handed down an extensive, complex and keenly awaited judgment in the Lloyds Banking Group case. The Court has ruled that pension benefits must be equalised for the effect of guaranteed minimum pensions (GMPs) accrued between 17 May 1990 and 5 April 1997, a decision that will have significant implications for most defined benefit pension schemes.
This is a very important decision for trustees and employers to consider. While actual changes to benefits will in practice be extremely complicated and so require detailed planning, there will be immediate issues to address, such as communication with affected members; the effect of the decision on the employer’s accounting position; the impact on scheme funding and the calculation of transfer values; and checking the wording of scheme limitation and forfeiture rules.
Conversion of GMPs, which has been an option that has lain dormant for over a decade, will now come to the fore as a way of mitigating what will otherwise be long-term increases in administration costs.
Background to the case
GMPs are the minimum pension which a formerly contracted-out defined benefit scheme must provide in respect of benefits earned between April 1978 and April 1997. There are a number of differences in the calculation of GMPs between men and women: most notably, they are payable to men from age 65 and to women from age 60.
The Government has consistently taken the view that for members who accrued GMPs from 17 May 1990 (the date of the European Court decision in Barber), European law requires the removal of any inequality resulting from the different GMP rules, so that schemes must adjust benefits in excess of the GMP to ensure equality. However - at least until today - there had been no clear case law to support this.
The picture is complicated by the fact that as the GMP itself remains unequal an individual can be better off at different times depending on whether the male or female calculations apply.
This litigation, concerning defined benefit pension schemes within the Lloyds Banking group, sought to address these issues.
Equalisation: the Court’s decision
The judge, Morgan J, was first asked to decide the crucial question of whether schemes are obliged to equalise for the effect of GMPs. He held that they are.
The Court heard detailed argument on the alternative methodologies. In broad terms, the viable options involved equalising each unequal aspect of the pension separately (Method A); providing the better of male or female comparator pensions on an annual basis (Method B); or providing the better of male or female comparator pensions each year, but subject to an accumulated offsetting process over the lifetime of the pension (Method C).
In evaluating the proposed methods, the judge applied the legal principle of “minimum interference”. When a court compares competing possible options to provide equal benefits, it should choose the one involving least interference with the rights of any party.
Of the proposed methods which provided equivalence of benefits, the Court held that the employers could require the trustees to adopt “Method C2” (which provides for the better of male or female comparator pensions each year, subject to accumulated offsetting, but making allowance for interest). The other methods, by increasing the cost to the scheme employers beyond that, would infringe the minimum interference test.
The judge also confirmed that equalisation in combination with the one-off actuarial equivalence test under existing “GMP conversion” legislation would be available to the parties, if the employers chose to agree to it. A one-off test that left GMPs in place (Method D1) would not be allowed.
Correcting past underpayments
In general, pension arrears were due to beneficiaries and would not be subject to any limitation period. It was appropriate, too, to apply simple interest on backpayments (of 1% over bank base rate).
After reviewing the forfeiture and unclaimed benefit rules of the relevant pension schemes, however, the judge ruled that these beneficiaries were not entitled to arrears for periods prior to six years before a claim was brought (although in one scheme, the trustees had a discretion over such arrears).
This is a very important decision for trustees and employers to consider. While actual changes to benefits will in practice be extremely complicated and so require detailed planning, there will be immediate issues to address, such as communication with affected members; the effect of the decision on the employer’s accounting position; the impact on scheme funding and the calculation of transfer values; and checking the wording of their scheme limitation and forfeiture rules.
However, the ball is still in the Government’s court on several matters potentially critical to implementing GMP equalisation. It has been broadly supportive of changes allowing trustees to use the existing GMP conversion legislation and dealing with any unintended tax consequences. These workstreams had been put “on hold” pending today’s judgment, but should now resume. The judgment also expressly leaves other points open, such as the treatment of past transfers-out and the proper approach where the cost of administering equalisation under the chosen methodology would exceed the benefit obtained.
There is much to digest following this decision and we anticipate that schemes will have a range of further questions. Please speak to your usual CMS contact if you require assistance.
The full judgment can be found here.