Trustees should review their commutation factors or risk large payouts down the line

What happened?

In May this year Pension Ombudsman Tony King ruled in favour of a retired firefighter who had complained that the cash lump sum he received on retirement had been incorrectly calculated.

William Milne was one of a group of retired firemen who had complained to the Ombudsman in the wake of a 2009 High Court ruling relating to the Police Pension Scheme, which calculates these lump-sum payments in a similar way to the Firefighters’ Pension Scheme.

For most other public service pension schemes commutation factors are defined in their rules, with members typically receiving £12 for every £1 of annual pension given up.

With the police and firefighters schemes, however, the rules require that the cash sum obtained from commutation is actuarially equivalent to the pension given up, with tables from the Government Actuary’s Department (GAD) being used to calculate the exact sums.

While GAD had historically reviewed both schemes’ commutation factors on a regular basis, no reviews were carried out between 1998 and 2006. This meant that when Mr Milne retired in 2005 his lump sum was calculated using out-of-date assumptions.

As the earlier High Court decision relating to the Police Pension Scheme found that GAD had a statutory duty to regularly review the commutation factors, Mr Milne accused it of maladministration and the Ombudsman agreed.

What does it mean for trustees?

Although the Ombudsman said Mr Milne has to be put in the financial position he would have been in had his lump sum been calculated correctly, GAD was not ordered to make any additional payment he may be entitled to – this will come out of the Firefighters’ Pension Scheme itself.

Any member of the firefighters’ or police scheme who retired between the end of the 1990s and 2006 is also likely to be entitled to an additional payment, meaning trustees will have to move fast to help identify who they are so their lump sums can be recalculated.

While other public sector schemes will not be directly affected due to the different way in which their commutation values are calculated, trustees should take a closer look at their scheme rules to establish who is responsible for reviewing commutation factors.

“While this determination is very specific to this particular scheme it highlights the importance to trustees of private sector schemes and their actuaries of regularly reviewing commutation and other factors to ensure they remain appropriate,” says Janine Bennett, a consultant at Towers Watson.

“It is also a timely reminder to establish who has responsibility for ensuring those factors are reviewed – under most scheme rules it will be the trustees.”

What’s next?

The Ombudsman was very clear that the issue of liability was secondary to the decision he was being asked to make. However, with the police and firefighters’ schemes likely to have to make substantial payments to rectify the mistake, the question of how this should be funded will have to be answered.

“In due course there will be the need for discussion with the Department for Communities and Local Government or the Home Office over the wider liability issues, since the global price-tag resulting from this decision is unlikely to be small,” says Eversheds partner Gary Delderfield.