12th November 2018 Lloyds pensions ruling: much needed clarity provided on guaranteed minimum pensions
Following last month’s landmark High Court ruling on Guaranteed Minimum Pensions (GMPs), namely that Lloyds Banking Group must equalise some legacy benefits for men and women, the newspaper headlines were perhaps predictable. The focus, even from the BBC and The Times, was that gender equalisation of pension pay outs could have a potentially detrimental effect, adding £15-£20bn to the costs of UK defined benefit pension schemes.
It’s a headline grabbing number. Pension funds involve large amounts. The combined total deficit in DB schemes can fluctuate wildly from one month to another (PwC’s Skyval index showed a 50% increase of £80 billion in the month to October 2018). The GMP issue affects thousands of pension schemes and will be spread over future decades. By taking this angle, the media reports rather miss the central point of Mr Justice Morgan’s lucid, carefully crafted judgment, which focuses on the complex interpretation of equality in relation to the interface between State and private pensions. State pensions were allowed to be unequal and that inequality is only now being eliminated. Although the employer lost on liability, which cannot have come as a complete surprise, it won on most of the issues of quantum. The true costs for employers will surely be much smaller than the worst case estimates. Also, despite headlines about windfalls, the uplift for most individuals will be tiny.
It is nearly 30 years since another landmark judgment, the Barber case in 1990, was delivered by the European Court of Justice. This confirmed that an obligation exists to treat men and women equally in relation to benefits under an occupational pension scheme.
We have known ever since that pensions have to be equal. It took four years, however, to get clarity about whether this applied to all pensions whenever earned, or (as it turned out) just pensions earned after the Barber ruling. We learned that it is the overall benefit that has to be equal for men and women, not the GMP itself. But it has taken 28 years to get clarity over how that could actually be done. Now the Lloyds judgment has brought significant clarity for trustees and employers alike on the final stage of gender equalisation in pensions, and based on the logic of the analysis, it seems unlikely that it will be appealed.
The current pension differences between men and women are not straightforward. Lawyers sometimes call it the ‘Jack or Jill’ approach. Usually, it is better to be Jill before 65, then you would want to switch to being Jack. The Court said you cannot be ‘part Jack and part Jill’ from 65; this would be gold-plating the benefit, effectively giving both sexes something that neither was entitled to before. Nor can you switch as soon as his monthly pension begins to overtake hers, unless the employer agrees to that approach. All you can insist on is to wait until his total pension payments from retirement surpass hers. The Lloyds judgment went further – it is not the cumulative amount that matters, but the cumulative value. Interest is to be included in order to take account of the value of Jill having had more earlier. On the worked examples in the case, the crossover age was 91.
UK legislation says each term of a pension scheme must be equal. That actually sits more comfortably with the gold-plating approach. This is why we consider the ruling, based as it is on the principle of minimum interference with the rights of employers as well as employees, to be helpfully purposive.
While it is correct to state that there will be a cost for schemes that were contracted-out of the State earnings-related pension scheme [SERPS] between May 1990 and April 1997, the market has been increasingly aware of this risk for several years. The extra cost arrives at a time when funding levels are under pressure and many employers are struggling to support their defined benefits (DB) legacy. Just the costs of advice on implementation will add to the funding burden. New market solutions may emerge quickly.
The judgment gave some comfort to both sides. Although the beneficiaries won the entitlement to equal benefits and arrears with interest, the employer (Lloyds) won the right to insist on the lowest cost solution, which in many cases had a six-year limit on arrears, and a low rate of interest.
So what are the practical implications?
Because they depend to some extent on the rules, these will have to be worked through scheme by scheme.
Trustees will have multiple considerations. Since they now know the scope of the overriding duty to equalise GMPs, they should begin by exploring the options of how they are going to address the issue. They will therefore need to start scoping out what the potential costs might be. The scale of the impact will depend on specific circumstances, like age profile and relevant scheme rules, such as those relating to the benefit structure, retirement ages and treatment at GMP age, rates of revaluation and increase in payment. Meanwhile, sponsors may want to take the initiative and engage with trustees, especially if an actuarial valuation is imminent.
The immediate priority is going to be whether they should put a temporary hold on transfer values because they might be underpaying. Transfer payments are a broad brush approximation of a long-term stream of future payments, and they are not particularly sensitive to nuances in rules or a member’s individual circumstances. Is it possible to get a discharge for a one-off payment now? Schemes may be willing to offer a top-up later if required but there are practical problems in paying small amounts. The answers may depend on the trustees’ appetite for risk.
Trustees will also want to consider their communications strategy moving forward, as it applies to the employer and the affected members, both those who have retired and those who have not. They may want to ask employers to agree that 6 year limits will not run against members, in order to take the time pressure off.
A number of points not dealt with by the judgment are yet to be decided. These will affect all schemes, such as the treatment of transfers and deaths, and de minimis thresholds where perhaps the cost of calculation could exceed the capital value. It would therefore be premature to make any immediate commitments to members.
As a measure of its significance, the Secretary of State for Work and Pensions and HM Treasury were joined as parties to the Lloyds case. Given the protracted uncertainty, the Government wanted to know what the judge’s answers would be on the relevant issues before considering what action it should take in relation to GMP equalisation.
Although the conversion legislation is not perfect, the majority of schemes will want to simplify the administration involved by converting GMPs into something that behaves in the same way as the rest of the pension. The Court ruling gives support to the view that the conversion legislation can be made to work. More regulations may be required but the DWP has indicated in the past that it is willing to work with the industry to fix any defects.
There will undoubtedly be teething troubles as the industry begins to absorb the implications of this ruling. Nevertheless, the direction of travel on GMPs now seems clear: reconcile, equalise, convert. A significant obstacle to achieving long-term settlement of defined benefit pensions has finally been removed, after a generation of uncertainty. The time to engage constructively with the issues has begun.
Anna Rogers, Senior Partner
This article was published in Thomson Reuters
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. ARC Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.