How FTSE 100 companies are accounting for GMP equalisation
Christine Scott and Liz Duffy examine the impact of the Lloyds judgment on the accounts of FTSE 100 companies.
About the Lloyds judgement
In the Lloyds judgement, the English High Court:
- Ruled that the Lloyds Pension Schemes must equalise for the effect of unequal Guaranteed Minimum Pensions (GMPs) accrued between 17 May 1990 and 5 April 1997.
- Set out a range of methodologies that the trustees can use to calculate scheme obligations.
- Ruled that benefit payments should be back-dated subject to any limitations in the scheme rules, for example, in relation to time limits on the back-dating of benefit payments, with interest applied at the Bank of England base rate plus 1%.
The judgement did not deal with the treatment of transfers out or de-minimis considerations which are expected to be dealt with in a second hearing.
Guidance for pension schemes
While the October 2018 ruling relates specifically to Lloyds Pension Schemes, it applies to any scheme contracted-out between May 1990 and April 1997.
In March this year, the Pensions Research Accounts Group (PRAG) issued the following guidance:
- Accounting for Guaranteed Minimum Pension equalisation by pension schemes following the Lloyds judgement.
This is available to PRAG members only through the PRAG website.
Accounting by sponsoring employers
Sponsoring employers need to account for the impact of the Lloyds judgement by recognising obligations relating to the back-dating of increased pension benefits arising from GMP equalisation, where these can be measured.
Sponsoring employers are required by accounting standards to recognise a net defined benefit liability which reflects the difference between the present value of defined benefit pension obligations and the fair value of scheme assets, adjusted for, among other things, any changes to past service benefits and changes in underlying assumptions.
Permissible methods of equalisation under the Lloyds judgement
The judge, Mr Justice Morgan, considered several different approaches to calculating the cost of additional benefits due as a consequence of GMP equalisation: methods A to D2 are set out in Appendix B of the judgement. Of these, he identified two key approaches he considered viable for the Lloyds schemes - method C2 and method D2 - but did not necessarily rule out other methods for other schemes.
Method C2 is an administratively complicated annual check that members’ pensions paid to date would not have been greater if they were of the opposite sex and, if pensions paid would have in fact been greater, these are uplifted.
Method D2 is a one-off value-based uplift and conversion of the GMPs typically into ‘main scheme’ style benefits.
Anecdotally and from our examination of a sample of 21 FTSE 100 company accounts, C2 appears to be the most common method being applied by sponsoring employers, with D2 applying to a lesser extent. As far as we can establish, none of the FTSE 100 companies in our sample applied any of the other methods set out in the judgement.
How FTSE 100 companies are accounting for GMP equalisation
We examined the approach taken to accounting for GMP equalisation by 21 FTSE 100 companies with defined benefit schemes. The accounts in the sample had accounting periods ending on or between 31 December 2018 and 31 March 2019 i.e. accounting periods ending after the Lloyds judgement.
The accounts we examined were prepared in accordance with International GAAP but broadly speaking the same principles apply under UK GAAP to the accounting treatment of net defined benefit pension liabilities and therefore to accounting for GMP equalisation. The purpose of the reviews was to look for any lessons to be learned for sponsoring employers applying UK GAAP and to develop guidance based on the requirements of FRS 102.
ICAS guidance for sponsoring employers is now available.
Our findings are summarised across five key themes:
- Retrospective or prospective accounting?
- Narrative disclosures.
1. Retrospective or prospective accounting?
While not all the companies in our sample of 21 refer to GMP equalisation in their accounts, none refer to the impact of GMP equalisation, estimated following the Lloyds judgement, as being a change in accounting policy or the correction of an error. Therefore, where the impact of GMP equalisation, following the Lloyds judgement, is being accounted for, it appears to be accounted for prospectively.
Companies are already required to recognise net defined pension liabilities, including from the payment of GMPs where schemes are contracted-out, and estimates of the additional cost of GMP equalisation form part of those liabilities.
Does this mean that accounting for the impact of GMP equalisation following the Lloyds judgement should always be a change in accounting estimate? Not necessarily.
Commentary published to date by KPMG and PWC consider that the impact of GMP equalisation following the Lloyds judgement is most likely to be regarded as additional cost arising from a plan amendment, thus classifying these as past service costs. Past service costs are accounted for through profit or loss.
However, where the effects of GMP equalisation were accounted for previously, the firms consider that applying a methodology permitted by the Lloyds judgement for the first time may be a change in accounting estimate to be accounted for through other comprehensive income.
Treatment as a plan amendment is the approach taken by companies in our sample adopting, or appearing to adopt, method C2 following the Lloyds judgment where the effects of GMP equalisation do not appear to have been accounted for previously. However, the one company in the sample appearing to adopt method D2 describes the impact as a revision of financial assumptions, suggesting that the company may have considered this to be change in accounting estimate.
Eighteen of the companies in the sample refer to GMP equalisation and recognise an increase in their net defined benefit liability as a result. Only three of those 18 refer to the methodology they have chosen to apply, which in all three cases is method C2.
However, it is possible from other information in the accounts of the 18 which did not refer to the methodology to conclude that at least 17 of these companies may have applied method C2 and with only one possibly applying method D2.
The 17 which may have applied method C2 recognised the additional costs of GMP equalisation through profit or loss. Fifteen specifically classified the additional costs as past service costs in arriving at their net defined benefit liability at the balance sheet date.
The company assumed to have applied method D2 recognised the additional expense through other comprehensive income. Its pensions note reported the impact on the net defined benefit liability as the effect of changes in actuarial financial assumptions.
Of the three companies which do not refer to GMP equalisation, it is unclear whether they have been unable to produce an estimate of its impact on their net defined benefit liability, whether the amount involved is not material or whether their schemes were contracted-in.
Nevertheless, it appears more likely than not that companies more generally should be able to recognise the impact of GMP equalisation, where it is considered to be material. This can be achieved without waiting for any related adjustments to be made by scheme administrators to the benefits of scheme members and other beneficiaries.
Of the 18 companies in the sample referring to GMP equalisation, no line items in any of the primary statements make a reference to GMP equalisation. This is not an unexpected finding.
Of the 17 companies which treat the impact as an expense through profit or loss, key observations on matters of presentation are as follows:
- Two companies include the related expense within exceptional items.
- 15 companies classify the adjustment to the net defined benefit liability, reported in the balance sheet, as a past service cost in the pensions note, including the two companies treating the related expense as an exceptional item.
With regard to the company which treated the impact as an expense through other comprehensive income, key observations regarding matters of presentation are as follows:
- The related expense is presented in other comprehensive income across two line items under the heading ‘remeasurement of retirement benefit schemes’, the main line item of relevance being ‘other movements’.
- In the statement of changes in net equity the ‘remeasurement of retirement benefit schemes’ is presented as movements in retained earnings.
- In the pensions note, the impact on the net defined benefit liability in the balance sheet is included within one or more line items under the heading ‘statement of comprehensive income’. However, it is not possible to identify precisely which line item or items is/are relevant.
- Narrative disclosures within the pensions note identify the impact of GMP equalisation as ‘financial assumptions in respect of equalisation’ recognised in equity.
This company adopted a dual presentation approach presenting an income statement and separate statement of comprehensive income.
5. Narrative disclosures
Narrative disclosures around the Lloyds judgement and the impact of GMP equalisation on the net defined benefit liability vary in terms of the location in the accounts and the level of detail provided.
Where GMP equalisation is referred to, the surrounding narrative, unsurprisingly, tends to be in the pensions note. Variation in the level of detail is also to be expected given that the impact of GMP equalisation across such a wide range of companies varies in terms of financial significance.
While eighteen companies in the sample refer to the Lloyds judgement, only three refer to the method selected to measure the impact of GMP equalisation. As the method impacts directly on the accounting treatment, narrative disclosures are falling short by not referring to this.
We also picked up references to GMP equalisation in the notes covering exceptional items where the impact had been classified as an exceptional item and on occasion within the staff costs note.
As far as we can establish no companies in our sample adjusted their net defined benefit liability for the impact of GMP equalisation in accounts relating to reporting periods ending prior to the Lloyds judgement. Our findings, therefore, indicate that the Lloyds judgement and the inclusion in the judgement of permitted methods have been the catalyst for change in the way the UK’s largest companies approach the impact of GMP equalisation in their accounts.