How to manage your scheme's payment error risk

But aiming at perfection cannot rule out the risk of overpayments and underpayments arising, even in the very best run pension schemes.

For trustees and managers, incorrect payments can be time consuming and complex to address with the added challenges of rectification within regulations, HM Revenue & Customs tax rules and avoiding triggering unauthorised payments.

Alongside compliance risk there is also the reputational risk through dispute procedures being invoked and cases being taken to the Pensions Advisory Service and the pensions ombudsman.  

For employer sponsors, incorrect payments from the pension scheme may generate concerns around reputational risk and if the result is that defined benefit liabilities are changing, this will inevitably raise questions on the effectiveness of pension scheme governance controls.

The theory is quite simple – benefit entitlements already settled and those still to be paid in future should be calculated as required by the governing documentation and legislation.

They should reflect what is valued by the actuaries and what has been communicated and quoted to members in personal benefit statements and other communications.

However, practice and theory can differ. The matters below will be familiar to many and illustrate the most common sources of mispayments – but it is good to know that for each one there is a preventative action that can be taken to rule it out or to mitigate the impact:

• Administrator error;

• Data issues – especially where related to past corporate activity;

• Company or payroll error;

• Retrospective changes to the pension scheme rules – such as sex equalisation, age discrimination or where there has been a successful challenge by members;

• Beneficiaries ceasing to be entitled to a benefit and where pension payments continue after death.

Where incorrect payments have been made, trustees will take advice and will typically correct the future benefits members are entitled to. They must then take steps to recover overpaid amounts and rectify underpayments.

Dealing with mispayments

Remedial action should be implemented efficiently and also with sensitivity, particularly where benefits need to be repaid or reduced.

It may not always be possible to recover overpayments. The recipient may have a successful defence by claiming they have changed their position on the back of the overpaid benefit by altering their lifestyle in a way that cannot be reversed.

There are also regulatory and rule restrictions to be complied with.  For example, with overpaid pensions there are HMRC rules around unauthorised payments and there are limitations on offsetting overpaid pensions from beneficiaries’ entitlements.

Being prepared and ready to respond is key. There are some basic governance points that can be dealt with up front:

• Document or review the process for dealing with under and overpayments including the policy on tolerance and de minimis levels, compensation and interest, and recovery of historic overpayments;

• Ensure there is an efficient complaints and error escalation process to address issues early;

• Agree the process for engagement with the employer or employers;

• Use project management for large exercises;

• Agree the communication approach and provide a helpline if relevant.

Reducing payment error risk

So what can be done to reduce the risk of paying incorrect benefits?

• Create an efficient employer interface with the administration system – particularly relevant for defined contribution arrangements.

• Conduct a data quality audit including guaranteed minimum pensions for DB contracted-out arrangements and implement a cleanse plan. Deal with known issues and manage dependencies between initiatives.

• Ensure optimal automation of benefit calculations, and robust check and control processes.

• Evidence the monitoring of continuing entitlement to children’s, ill-health and bridging pensions.  

• Make sure legislation has been properly reflected in the governing documents and practice.  

• Consider a benefit audit – particularly where there is a history of multiple employers and administrators – in order to verify that the underlying calculation routines match the rules and the relevant regulations.

Communication should not be underestimated. It should explain the cause and remedy in understandable terms, and be delivered with sensitivity.

June Grant is a principal at consultancy Aon Hewitt