HIGH COURT RULING EXPECTED IMMINENTLY
A High Court judgment on addressing inequalities in Guaranteed Minimum Pensions (GMPs) is expected any day. The Court has been asked three questions –
Do GMPs need to be equalised?
If so, how?
If so, how should trustees exercise their powers?
Most commentators are expecting the first question to be answered in the affirmative and the consequence of this is that the cost for affected schemes could be around £20 billion. Or, to put it another way, the liabilities of affected schemes could increase on average by around 2 per cent. Trustees and employers need to start planning for the outcome of this case now.
What are GMPs?
The State Pension for people who reached State Pension age before 6 April 2016 had two tiers - the basic State Pension (which was flat-rate and dependent on an individual’s NI record) and the additional State Pension – which was partly earnings-related.
It was possible to contract out of the additional State Pension into an occupational pension scheme that met set criteria. Where an employee was contracted-out, they and their employer paid a reduced rate of National Insurance (NI), to reflect the fact that they were forfeiting additional State Pension rights for that period.
Between 1978 and 1997, contracted-out schemes were required to provide a Guaranteed Minimum Pension (GMP). Since 1997, a different test has applied but contracted-out schemes still have to provide a GMP for rights accrued between 1978 and 1997.
ACTIONS FOR TRUSTEES
Assuming the High Court rules that inequalities in GMPs must be addressed (equalised) then trustees willneed to consider –
The integrity of GMP data because how can you equalise something if you are not sure your GMP records are correct in the first place? GMP equalisation is another reason why all schemes should be reconciling their GMPs with HMRC data before this option ceases to be available at the end of the year.
What they are going to do about benefit recalculations for current, prospective and contingent pensions (where an inequality is discovered then members will always be due a top-up; i.e. unlike GMP reconciliation, equalisation will not result in any overpayments having to be recovered)?
What they are going to do about more difficult cases - commutations, transfers, deaths, etc.? The High Court is not expected to provide any guidance on this.
The impact on scheme liabilities / funding.
ACTIONS FOR EMPLOYERS
Employers will also want to know about the impact on scheme funding but, in addition, they need to consider the impact on their financial statements.
Accounting standards require companies to recognise liabilities that they have a legal (or constructive) obligation to provide. The legal clarity provided by the expected ruling will effectively require trustees to equalise GMPs and so triggers the need for immediate action in accounting disclosures.
Companies will be required to include this additional liability on their balance sheets which will lead to increased deficits or reduced surpluses. It is also expected that the impact will be treated as a plan amendment and so will be immediately recognised in Profit & Loss (P&L). Companies need to consider the impact of this now and amend budgets or forecasts if required.
The increase in liabilities could be 1-3% depending on the scheme demographics and historic benefit structures which is not necessarily a significant balance sheet event compared to the potential impact of market movements in any given period. However, 1-3% of liabilities recognised through P&L could be a material figure and create issues with company budgets and forecasts. There are possible alternative approaches to accounting for this (for example through other comprehensive income or treating it as an error resulting in restatement of prior years). However, we believe that the most likely outcome is that auditors will expect it to be recognised in P&L.
It will not be possible to place an accurate value on the impact given such short timescales, so a reasonable approximate will be required. Corporate consultants will be able to support you with this.
A FIRST STEP
Speaking at the Society of Pension Professionals annual conference, Allen & Overy partner, Jane Higgins, said that schemes should be thinking about how they communicate with their members prior to the decision being handed down. Allen & Overy are legal advisers to the trustees of the Lloyds Bank pension schemes.
According to Higgins, trustees should be thinking about managing member expectations – “… actually thinking about communications to members and starting to manage expectations to the extent you can, because it’s not going to be a day one simple answer as to how it impacts members, you are going to have to go through quite a long process with the answers and then you’ll find a way to do it”.
A SILVER LINING?
Addressing inequalities in GMPs will be a major project but, at the end of it, there is an opportunity to simplify scheme administration by converting the equalised GMPs into ordinary scheme benefits; i.e. you can get rid of the ‘GMP headache’ for good
For more information please contact: John Wilson | +44 (0) 131 456 6850 | firstname.lastname@example.org