As you may have seen, the High Court has ruled that pension schemes must equalise for the effect of unequal Guaranteed Minimum Pensions (GMPs). While this decision did not come as a surprise (we have all known of the need to deal with the unequal application of GMPs for some time), it will have significant implications for most defined benefit pension schemes. Thankfully, the decision is helpful because it provides some guidance on how schemes should go about equalising GMPs, which has always been the issue. While an equalisation exercise is likely to be complex and costly, scheme rules may provide some protection by limiting the period for which arrears of pension can be claimed.

In summary, the High Court ruled that:

1. Pension schemes are required to equalise for the effects of unequal GMPs.
2. The method of equalisation applied must cause minimum interference for the parties involved.  If there are competing methods that meet the minimum interference test, the employer can require the trustees to apply the method that costs the least.
3. Pension schemes do have to pay arrears to members with interest.
4. Claims to arrears are subject to any limitation period set out under the rules.

This is an important decision for trustees and employers to consider. While actual changes to benefits will, in practice, be extremely complicated and 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.

What is the issue?

GMPs are the benefits that a formerly contracted-out scheme must provide in respect of benefits earned between April 1978 and April 1997.  These schemes chose to contract-out of the State Earnings-Related Pension Scheme (SERPS), the top up element of the basic state pension. Where a scheme contracted-out of SERPS, the sponsoring employers and active members of that scheme paid lower National Insurance contributions and the scheme provided GMPs, broadly as a replacement for the SERPS benefit that would no longer be paid by the Government.

GMPs are inherently unequal because they are paid at different ages to male (65) and female (60) members.  But EU and UK law require that men and women are treated equally in relation to benefits payable from occupational pension schemes. The age at which GMPs are paid, and the way in which GMPs are calculated, revalued in deferment, and increased in payment is set out in legislation – so the GMP itself cannot be equalised.  Any inequality between male and female members can therefore only be addressed by making changes to the non-GMP benefit in the scheme (the “excess”).  And that inequality must be equalised for the period from 17 May 1990 (the date from which benefits must be equalised) to 5 April 1997 (when GMPs were replaced with a new contracted out benefit).

The position is further complicated by the fact that an individual member (male or female) can be better or worse off at different times depending on the stage at which the benefit is calculated. Generally speaking, the rates of revaluation in deferment tend to benefit women; the rates of increase for pensions in payment tend to favour men.

In summary, scheme benefits in excess of GMP must be adjusted so that the total benefits received by male and female members with equivalent age, service and earnings histories are equal.

How should you equalise for the unequal effect of GMPs?

The High Court considered 4 main methods of equalisation (some of which were split into “sub-methods”), each with a different price tag.

In the case considered by the High Court any of Methods A, B, C or D2 would be permissible methods by which to equalise, but Methods A and D2 would require employer consent.

The High Court ruled that where more than one of the methods put forward would achieve equalisation of benefits, the trustees of the scheme should choose the method that results in ‘minimum interference’ with the rights of any party (ie. the affected members and the employer).  In this case, the sponsoring employer, as the funder of the scheme, was entitled to insist that the trustees use the least costly method (Method C2).

The High Court did not rule at this stage on how previous transfers out should be treated or what approach trustees should take if the costs of dealing with GMP equalisation are more than the value of the top up benefits due to members.

How far back should you go when correcting unequal benefits?

The High Court also considered how far back trustees should go when correcting unequal benefits.  In this case, most of the scheme rules in question stated that members could only claim benefits going back 6 years.

The High Court ruled that there is no limitation period applicable under legislation for claims for payment of arrears from a pension scheme in these circumstances.  However, the scheme rules may limit such member claims.  Many schemes do contain a forfeiture or unclaimed benefits clause which provides that claims for benefits must be made within a certain number of years. It will depend on the precise wording of the specific scheme rule, but where there is such a provision it is likely to limit the costs of equalising benefits. The position is more complicated where the scheme rules leave the decision on whether benefits are forfeited to trustee discretion.  Where this applies, the High Court confirmed that in exercising that discretion, the trustees must have regard to all relevant and no irrelevant considerations and make a decision which is rational and not perverse.

The High Court also confirmed that simple interest is payable on any arrears payable at 1% above base rate

What should you do now?

The impact of GMP equalisation is wide ranging, complex and potentially costly. The Government (which was joined as a party to the hearing due to the importance of the case) has said in response to the ruling that it will be issuing further guidance on GMP equalisation.

But for now, the key areas that will be affected and should be considered by trustees and employers are:

1. Funding / accounting valuations – any extra liabilities will need to be quantified and may impact the funding position of the scheme and / or the company accounting position.
2. Administration / member payments – as well as uplifts in respect of historical payments, schemes will also need to consider the implications for future payments including transfer values, trivial commutation and retirements.
3. Communications with members – consider whether you should send a specific communication to members who may have seen the (at times sensational) press coverage over the weekend and have questions relating to their own benefits.
4. Investment strategy – if GMP equalisation changes the funding position of the scheme, the investment strategy may need to be revisited.  
   5.Buy-ins / buy-outs – schemes that have implemented, or are considering, a buy-in or buy-out will need to factor in the potentially higher pensions payable.

Please get in touch with your usual Burness Paull contact if you would like to discuss the position of your scheme with us.

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