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GMP equalisation presents a new challenge for many pension schemes, but don’t panic, because the issues it presents can all be resolved and there is a genuine alternative now available through GMP conversion to potentially simplify and reduce the ultimate cost of pension schemes.
What is unequal with GMPs?
Guaranteed Minimum Pension (GMP) is the minimum pension entitlement for members who were contracted out of occupational pension schemes, salary related pension schemes (COSRs) and State Earnings Related Pension Schemes (SERPS) prior to April 1997. Employers could contract a scheme out of the State Earnings Related Pension Scheme (SERPS) if it was designed to provide a pension as good as a GMP.
Original legislation set out the method for calculating GMPs which led to inequality because GMPs are payable at 65 for men and 60 for women and ultimately accrue at different rates.
Lloyds court case
Pension schemes have known about the need to equalise GMPs for over 20 years but most have not taken action to date due to the complexities of the subject and the lack of clarity.
On 26 October 2018 the High Court of Justice ruled that the Lloyds Bank pension schemes do have to carry out GMP equalisation, with the ruling being expected to broadly apply to other ongoing pension schemes.
The case described year-on-year comparison methods of GMP equalisation which will be onerous for ongoing schemes to adopt, with more expensive options needing employer consent.
The silver lining from the Lloyds Bank judgement is that it also provided clarity over using the GMP conversion regulations. This also requires employer consent but that is unlikely to be withheld if trustees and employers are working together to find the optimal solution.
"GMP conversion considers the actuarial value of the unequalised male and female pensions and converts the more valuable of the two into a new benefit structure."
GMP conversion considers the actuarial value of the unequalised male and female pensions and converts the more valuable of the two into a new benefit structure, thus achieving equalisation and hopefully some significant simplification.
GMP conversion legislation considers not just GMP but all pension earned before 6 April 1997. So we could change our pension schemes to have a single benefit structure for all pension accrued pre 6 April 1997.
The skill is in picking a new benefit structure that successfully negotiates the various hurdles described later, but conversion has the potential to:
- Achieve GMP equalisation as a one-off exercise without the need to carry out a year-on-year comparison
- Make the scheme simpler to understand for members
- Reduce risk within the scheme such as inflation risk
- Make the scheme easier to administer
- Reduce ongoing administration costs
- Reduce buyout cost
A key consideration will be the impact on members. How will they feel about any changes? We’re exploring the feasibility of conversion with our clients and we would encourage others to do the same, bearing in mind the impact on members and the hurdles set out below.
Issues facing GMP conversion
While GMP conversion is an option, there are various issues that face trustees and employers during the process.
Before carrying out conversion, GMP reconciliation should be completed and any data or benefit issues resolved.
Not all tranches of pension can be converted
Under the GMP conversion legislation, non-GMP accrued before 6 April 1997 for a particular member cannot be converted if that member does not have any GMP. However such benefits could still be converted under section 67 of the Pensions Act 1995. Pension accrued after 5 April 1997 is also out of scope of the GMP conversion legislation.
Pensions in payment cannot reduce
Legislation does not allow pensions in payment to reduce (or where a right to payment has arisen). This means that there could be a problem if you wanted to create a more generous benefit structure with a lower initial pension in payment.
Annual and Lifetime Allowance issues
Increasing the underlying amount of pension could cause the Annual Allowance or Lifetime Allowance to be breached or certain protections to be lost. The Association of Consulting Actuaries has written to HMRC asking for these issues to be addressed.
Changing benefits will be an expensive one-off exercise, but perhaps the marginal cost compared to GMP equalisation will not be as much as you think, and avoiding the year-on-year comparison methods of GMP equalisation should avoid cost increases in ongoing administration.
"It may come as a surprise, but GMP equalisation has been carried out for 15+ years for schemes winding up and more recently for schemes going into the PPF."
How does conversion compare with equalisation?
It may come as a surprise, but GMP equalisation has been carried out for 15+ years for schemes winding up and more recently for schemes going into the PPF. At Barnett Waddingham we have carried out GMP equalisation for over 100 schemes using a range of methods including cases for our role on the PPF’s specialist panel.
We have the capability to equalise GMP using whatever method our clients ultimately select and have our own administration systems that can be programmed to carry out the various different year-on-year methods of GMP equalisation for each individual.
However, whatever method is ultimately chosen to equalise GMP going forward, an exercise will be needed to equalise benefits already paid and adding on a conversion exercise to cover both the past and future in one go seems like an attractive option.
Imagine being able to explain the scheme’s benefit structure without referring to detailed schedules and anti-franking rules. Imagine a pension scheme that is easy and straightforward to govern. Imagine a world where pension scheme administration is cheaper too…
That may all be a leap of imagination too far but for bold companies and trustees willing to grasp the nettle we think it is possible to achieve a genuinely simpler pension scheme.
Barnett Waddingham are experts in GMP equalisation and can support various employers with their pensions. Get in touch today to get started.