Panellists at a PP webinar discuss October's High Court judgment on GMP equalisation, how schemes have responded, what their strategies should be, and how the industry can approach it.
Client relationship director
Capita Employee Benefits
Lynda, could you summarise the High Court judgment on GMP equalisation?
Lynda Whitney: First of all, the court said you have to equalise. There were eight methods considered in four broad categories, only one of which the judge ruled out.
Method A looked at equalising each benefit of the guaranteed minimum pension (GMP) separately. So, for example, equalising for differences in the way accrual worked, for deferred increases, and for increases in payment.
Method B looked at the annual pension being paid to a man and a woman and said we pay the better each year.
Method C1 is similar in that it equalises each year but it also keeps a cumulative running total.
Method C2 is effectively the default. It keeps this running cumulative total but it also adds interest using simple interest and a bank base rate plus 1%.
Method D1 is the actuarial solution and the only one that was ruled out. That was a projection with assumptions and then a comparison of values. It was ruled out as it was felt it didn't necessarily achieve equalisation.
Finally, method D2 is conversion where you work out what an equalised benefit would be; you then put it into an actuarial sausage machine in order to create a much simpler benefit.
What are the general implications of the ruling, and what should schemes and sponsors be thinking about?
Geraldine Brassett: The judgment has created a degree of uncertainty about the timing and the implementation of equalisation.
So the checklist of things important to think about starts with the impact on members and individual member transactions and the need to communicate to members.
Other things not to forget are equipping frontline staff with frequently asked questions. You also need to consider what your websites say currently about GMPs and the potential impact of equalisation.
Other areas to consider are projects that are currently in flight, including any impact on plans around de-risking projects.
Maurice Titley: This will be a significant rectification project for most schemes. It will make some very heavy demands on data, such as identifying the elements of pension accrued between May 1990 and April 1997; the GMP data itself and the opposite sex GMP data; early retirement factors; cash taken; and links to deceased members where we're looking at dependants.
There will be a desire not to let these projects run away, to manage costs by prioritising the higher impact cases. Generally, the likely impact across a fund is only going to be pretty small but for any one individual it could be significantly higher. Focusing on those most impacted is key to controlling costs and carrying that project out efficiently and effectively.
There is a focus where schemes are about to apply GMP rectification and adjust members' benefits, particularly members who have been found to be overpaid. For some of them there will be an opposite adjustment for GMP equalisation.
Richard Gibson: There's a tendency with this topic to hear a narrative that's about complexity, different methodologies, and data limitations, and to give the impression of insurmountable issues. I simply don't think that's the case. Firstly and most importantly, don't panic, because this is not a new issue - we have been dealing with equalisation for schemes in wind-up for years. The ruling is not a surprise, and schemes will be able to work through it given time.
Schemes do need clear, pragmatic actuarial and legal advice, but also support in understanding their administrative capabilities and the implications of any decision on scheme administration. There are short-term tasks before schemes can look at adjusting the core pension benefit; including the need to quantify the likely impact of equalisation.
Realistically most schemes cannot adjust benefits or establish whether GMP conversion is viable for a number of months. That will be once reconciliation and rectification work is complete and administrators have undertaken the system improvements necessary.
What response have you already seen in the short term for schemes?
Geraldine Brassett: We're typically seeing many conversations around what approach to take to cash equivalent transfer values (CETVs). Most schemes are continuing to quote and pay CETVs to members who are in scope for GMP equalisation. It is really important to highlight in member communications if GMP benefits are unequalised so that members are making an informed decision if they do go ahead.
Secondly, schemes are looking at trivial commutations: is a member who qualifies for triviality now still going to post equalisation? What's the value that should be paid and does the member realise what they're extinguishing their rights to?
Lynda Whitney: We saw some initial interest from members in the first few days after the court case, particularly because of headlines around a ‘pensions windfall'.
With the exception of that, most schemes have been pretty quiet. This is a technical area and a lot of the materials we're putting together are to support independent financial advisers.
Communication is really important because there are some things in people's lives you can't stop. For example, you can't delay cases involving serious ill-health.
Maurice Titley: What we've seen has been GMP rectification projects and overpaid cases, where they might be reclaiming overpayments, reducing ongoing pensions, or freezing increases. Schemes are looking at the overlap between those and the members who are likely to have equalisation corrections.
You can calculate the likely impact in a way that allows some individual decisions on communications and withholding actions on overpayment. To carry on overpaying members because you're waiting to see what happens is not seen as acceptable.
We've also seen some activity on data quality assessments. Clients are looking at their data for other reasons but are now thinking about the data suitability for carrying out future equalisation corrections. This will happen more and more; any significant work on data cleansing should also consider the data requirements for carrying out equalisation corrections.
To what extent is conversion an option for schemes?
Richard Gibson: If there's one real positive from the judgment, it's clarity over GMP conversion legislation. This permits a scheme to remove the GMP and other pre-1997 elements, and replace them with pension benefits of equivalent value in whatever form they deem suitable.
The real benefit of this mechanism is that it allows us to remove complications. That makes it easier for schemes to administer and communicate what benefits genuinely are.
Also, if we use conversion to adjust away particularly expensive types of benefits to insure, such as those uprated with the consumer prices index, we can move a scheme closer to buyout.
Maurice Titley: The conversion method gives, to a certain extent, a carte blanche in how the benefits end up looking. If you have a scheme that isn't anywhere near a buy-in or buyout, this might be a little too arbitrary.
Schemes that are far from buyout are looking at C2 as the default method. Although on the face of it C2 sounds like an administrative nightmare, it should be possible to build it into administration software. It's not actually more complicated than current rules around GMP administration - it relies on good data.
Lynda Whitney: There's a big prize to be had in conversion if we can simplify administration, but I also do see problems.
I'm trying to project myself 28 years into the future when conversion has happened. A key assumption is how long a member lives. If you are paying them more now and less later and they live significantly longer than assumed, then actually they will have been worse off. I can see a situation where you're suddenly getting a new raft of complaints.
Geraldine Brassett: Many schemes have already gone through rectification exercises. It is definitely the art of the possible to implement C2 on administration systems.
I've heard lots of people say, quite rightly, if you undertake conversion, then your administration becomes simpler. Yes, but it makes your implementation project a bit more complicated and potentially longer.
Not only are you putting in place a project to undertake that conversion, you've got to change pretty much everything you do: your data holding, your calculations, your letters, your online offering, and your reporting.
A number of schemes have already used the D1 method so there's concern. Why did the judge not like that method?
Lynda Whitney: The legal principle is minimum interference. The judge was looking for a route that provided an equal benefit with the least interference. When he looked at method D1, he saw a method that needed to look across wider issues with more assumptions.
For D2, he accepted that using a more actuarial approach of looking at the value of the benefit was explicitly allowed in a separate piece of law. That's why I think D2 is allowed when D1 is not.
What should schemes do if they've used D1 in, for example, buyout deals?
Richard Gibson: If your scheme is in the process of winding up already, with a buyout or partial buyout, there are very few implications that you should read across from the Lloyds judgment. The judge was clear that he was opining on what specifically the Lloyds scheme should do, but that it would have implications for other ongoing schemes..
Even so, most buyout contracts do have GMP equalisation indemnities, a popular contractual term that grew in prominence four or five years ago. Insurers have talked about implications of how they will administer different and more onerous requirements around equalisation. You can probably rest easy if you have a buyout already.
How should companies be treating GMP equalisation in their accounting? How should the liabilities be recognised or treated, and what do you expect the overall impact to be?
Lynda Whitney: Schemes have to do an estimate for 2018's company accounts. If you've got a 31 December company year-end, your auditor will be expecting an estimate that you can put in your company accounts.
In addition, the auditors are seeing this as a cost that needs to go through the profits and loss (P&L). Although the percentages are quite small proportions of the overall scheme liabilities, they can be material in relation to P&L.
Richard Gibson: It's probably an unfortunate position for many corporates - they're having to cost the impact based on approximate data and on high-level methods that haven't yet had the benefit of legal scrutiny. Clearly there is potential for the figures they're reporting in their accounts to be different to the eventual cost for the scheme.
Lynda Whitney: Therefore it's important that they do get the wording right around their estimate and liaise with both the corporate actuary who is working on it and the auditor to make sure that any future changes are seen as a change in assumption, not a change in benefits. That should then give them greater flexibility to put it through Other Comprehensive Income rather than through the P&L.
Maurice, how long do you think it would take to develop administration systems to hold the required extra data?
Maurice Titley: I suspect it will be a couple of years before all systems are up to speed. It's already in the plans and it is already entering into their roadmaps.
Like any kind of GMP processing on admin systems, it is entirely dependent on the data. Preparing that to support the starting position for processing C2 is going to be absolutely key. That applies to C2, D2, and any other methods. The systems will be there to support it by the time schemes are confident enough to go forward.
How should employers in multi-employer defined benefit schemes approach GMPs? What happens if one wants to use a different method of equalisation to another employer in that scheme?
Richard Gibson: Ultimately, it's the responsibility of the trustees or the managers of the scheme to calculate correct benefits and to equalise GMPs as a result. We must apply the principle of minimum interference and trustees would need to have the sponsor's agreement before being able to use one of the more onerous or more costly methods. That's the kind of situation you'd be in, although I can half feel another court case coming on!
Lynda Whitney: So in terms of public sector pension schemes, the Local Government Pension Scheme, NHS, teachers etc are not directly impacted by the judgment. Steps had already been taken to work on the problem of equalising GMPs in public sector schemes and they are tackling it in combination with some other issues.
How should schemes approach past overpayments and what are the rules around clawback?
Geraldine Brassett: For past overpayments from a previous rectification exercise - for example, where you've frozen pension increases because you've discovered you've overpaid a member and now you've looked at equalising their GMP and you find you perhaps underpaid them - there are a number of points to consider. These include looking at precedents and seeing what's been done in the past, if you've had similar situations to this, and then potentially taking legal advice to understand the options.
But to ensure consistency and fairness in treatment of members, it's putting members' benefits in the position they should have been.
Maurice Titley: One of the potential options is reclaiming past overpayments. You need to know what you will do if members are going to have an underpayment due to equalisation. You might be able to hold back that portion of the past overpayment from any reclaim. But you don't want to leave something hanging over these pensioners - this overpayment situation is not their fault. It might reach the point where part of the past overpayment is written off. There are similar considerations when reducing pensions.
Trustees need to see the data. An awful lot of members will be impacted in such a tiny way due to equalisation, but potentially such a huge way because of rectification overpayments, so you really need to see that data before you take these decisions.
Lynda Whitney: It also shows why firms and trustees need to work together. When you're deciding whether to write off past overpayment, it's the firm picking up the bill. Now they may be quite happy to continue paying these overpayments, recognising we're not going to claim them back in some cases. Make that decision now to keep a cleaner message.
What does this judgment mean for existing rectification projects as well as reconciliation projects?
Geraldine Brassett: There is a desire to progress rectification. Trustees are mindful that they should be paying the right benefits to the right person at the right time, so they want to put people in the position that they should be. But there's also a recognition that, when we are in a position to do GMP equalisation, there is going to be a significant strain on the industry. So it's important that we do as much as we can now to be ready.
That does include getting the data in good shape, dealing with reconciliations, sorting out stalemate cases, and address tracing. It means rectifying in a cost effective way.
Maurice Titley: There are some practical approaches. For example, when you correct the dependants' GMPs, clients tend to not work with the deceased member to work out whether the deceased member's benefits were impacted by GMP administration. When it comes to GMP equalisation projects, that easement can't apply in the same way.
Have a look at your GMP rectification project, have a look at the data requirements for it, and be aware of how those data requirements are slightly more extreme for equalisation. That's not a reason to stop the rectification but it might be a reason to tweak something in your approach.
How should schemes be approaching statutory transfers, both those completed in the past and those that are pending? Should the previous transfers be retrospectively equalised, and do those in the pipeline need to be deferred until the scheme has decided which method to use?
Richard Gibson: There is very little clarity on revisiting past transfers out at present and many schemes are waiting to hear something further.
For transfer values currently being quoted, schemes are almost universally taking legal advice and there is quite a difference between the legal opinions. There's a variety between those who believe we must immediately adjust transfer quotes to explicitly reflect the effects of equalisation, usually following the C2 method; to those who believe it still possible to quote transfer values on the existing basis with the possibility of a subsequent payment.
Case by case, schemes should sit down with their advisers, discuss the approach and the implications.
If you have benefits in your scheme that have come from past transfers, I'm afraid they are your problem. Transfers out, however, we're waiting to hear a bit more.
In terms of transfers being made now, typically schemes are continuing to make payments, recognising that it's a statutory right of members to take their benefits. But for those who have benefits with GMPs between 1990 and 1997, they are typically flagging that there may be some form of follow-on payment.
I'm seeing different approaches from lawyers as to whether the first payment is a partial transfer and the second payment is completing that same transfer. Or whether actually the first payment is a payment in full but then the second payment to pay the equalisation is effectively some form of correction or accrued element.
If a scheme is close to completing a data cleanse as part of a bulk annuity deal, should they defer the completion of that cleanse?
Maurice Titley: I would definitely say complete it and I would say talk to your adviser. If you've already got through to the point of having a preferred insurer, or if you're in a true-up period, the insurer is going to be the person to talk to.
Insurers have made allowances for GMP equalisation and have methods that they ask schemes to use in terms of data preparation. How that has changed is a question for your actual insurer.
Do insurers have a preferred method for GMP equalisation?
Geraldine Brassett: At the moment we're in early discussions with a number of the insurers, but the ones that we've spoken to thus far, the method we've been talking to them about mostly is the C2 method.
Richard Gibson: Most insurers are currently developing the capability to administer the C2 method - the more onerous method. For schemes who are in the process of negotiating a buyout transaction, the jury is still out a little bit but generally I expect the approach will be equalising on a value-test basis, so on a D1 style basis.
Does the industry have capacity to deal with this large project?
Lynda Whitney: In terms of the immediate actions, that's clear and is being worked through. After that it's about having a measured project plan and recognising you're not going to do everything immediately; recognising that you do want resources outside of your existing teams, so they are not distracted from day-to-day work. I'm afraid it's probably a planned process to implement equalisation by perhaps April 2020.
Geraldine Brassett: Inevitably it's going to be very busy and we need to find a way to do this that doesn't impact on the day-to-day service for members. There are things as an industry we can do to help. These will be scheme-specific projects; each trustee will make their own decisions, and governance around recording those decisions and starting that now is going to be really important. But there will be areas where the industry could work together to develop best practice approaches. That's important for consistency, for support, for finding cost-effective solutions and for being able to process these projects in a timely way.
What data do schemes need to use to calculate and administer the C2 method? And if you've got a very old scheme, maybe data accuracy and availability is going to be a problem?
Maurice Titley: Key is the extent to which you have to go to data that is rather inaccessible because it's stored on file images. It needs to be looked at to some extent by human beings, case by case, in order to draw out what is actually needed.
In terms of preparing data for any of the equalisation methods, we've assumed pretty much the same level of data. The starting point is looking back over the splits of pension, understanding the sub-components, and what's happened with other equalisation that's already been applied.
There's also all the information you need to support any kind of historic rectification process, such as to understand what happened at the point of retirement, and cash taken, etc. Understanding all that is required when you're actually looking back and correcting the past.
Professional Pensions conducted this webinar in partnership with Aon, Barnett Waddingham, Capita Employee Benefits, and ITM. To listen to the webinar in full, click here.
Communication is essential in a pensions environment governed increasingly by defaults, and with more schemes in distress. James Phillips joined a panel of experts to hear how it can be improved.
Penfold has launched a digital pension scheme aimed at the self-employed following a successful £2m funding round.
The Pensions Administration Standards Association (PASA) has published its first batch of guidance on defined contribution (DC) master trust transition, as further consolidation is expected.
LCP’s Ella Purkiss was the winner of the PMI's second student essay competition. In her paper, she sets out her ideas as to what the industry can learn from other sectors when designing and delivering the pensions dashboard.
The lack of clarity from HM Revenue and Customs (HMRC) on guaranteed minimum pension (GMP) equalisation is “no excuse” for stalling implementation, says Aon.