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So after 28 years of uncertainty, the Lloyds Bank case judgment released on 26 October 2018 means we all now know what we need to know about equalisation of Guaranteed Minimum Pension benefits (GMP equalisation). Right? Hmmm. Maybe it’s more of a case of after 28 years of uncertainty we all now know we need to do something about GMP equalisation. But what?
Whilst the Lloyds case has provided clarity that something needs to be done, there are lots of options and companies need to take the lead in agreeing with trustees what is acceptable to them.
The judgment set out a number of options for equalisation but was very clear that it was within the employer’s remit to agree to it only when it is a cost effective approach. The judgement is based on the ‘principle of minimum interference’.
Most companies will prefer methods ‘C2’ or ‘D2’. Method C2 allows historic overpayments to offset future underpayments and hence minimises costs. Current pension scheme benefits consist of a hotchpotch of GMP and non-GMP benefits with different retirement ages and pension increase levels, resulting in complexity for members and administrators. Method D2 allows benefits earned before April 1997 to be equalised using method C2 and then converted into a simpler form of pension with a single level of pension increase and a single retirement age. Converting benefits through method D2 can help increase member understanding, reduce administration costs and lower the cost of buying out benefits with an insurance company. Companies need to ensure the approach with the lowest long term cost is followed by their pension scheme trustees. We think this will be method D2.
The ruling also made it clear that any historic underpayments need to be made good. However, many pension scheme rules (including the Lloyds bank schemes) include a clause limiting back payments, usually to six years. It is important that companies understand if this limit is in the rules of their pension schemes and to agree with trustees when the six year back payment period starts. This could be now, or it could be once the trustees have carried out the calculations necessary to work out any back payments. The later may be a year or two away yet and therefore would be result in a lower cost.
It is likely it will take many months or even years for the trustees of pension schemes to calculate the impact of this ruling on their members, and hence calculate a figure for how much the liability value and the scheme deficit will increase by. Given the long term nature of pensions it would seem appropriate for this amount to be wrapped up in the discussion at the next scheme funding valuation.
Audit firms have made it very clear that the impact of GMP equalisation now needs to be recognised on the company’s balance sheet at the next year-end. Our experience of the 31 December 2018 year-end has been that:
For most companies the impact of GMP equalisation was recognised on the company’s balance sheet via a prior service cost through profit and loss (P&L).
Calculations based on approximations and summary data are acceptable to audit firms. It is therefore important that where approximations are a reliable best estimate and do not overstate the impact of GMP equalisation.
If the impact is material to P&L, detailed audit scrutiny is likely to occur
In summary, as a sponsor of a defined benefit pension scheme impacted by the GMP equalisation ruling you will need to take the following actions (and number 4 is the one you need will probably need to tackle first!);
- ensure the approach to GMP equalisation used is the option with the lowest long term cost – probably method D2
- ensure the backdating period is limited as much as possible
- incorporate the additional costs and part of a long term funding agreement
- ensure a best estimate allowance is made in the year-end balance sheet
How does GMP equalisation affect you?
Listen to our past webinar from Head of GMP equalisation; John Cormell, as he guides you through all the implications and discusses what the judgement means for trustees and sponsors.Find out more