On 26 October 2018, the High Court handed down an important judgment on equalisation of guaranteed minimum pensions (GMPs) in Lloyds Banking Group Pensions Trustees Limited v Lloyds Bank plc and others [2018] EWHC 2839 (Ch) (28 October 2018) (Lloyds).

Since the judgment was handed down, trustees and employers of occupational pension schemes, and their advisers, have had to face the question of how to implement the equalisation of GMPs in practice.

This Insight is the first in our updated series of Insights on GMP equalisation. You can navigate between these Insights using the links below.

  1. GMP equalisation – what is the problem with GMPs? This Insight will provide an explanation of what GMPs are, how they work in practice and why they are unequal.
  2. What did the Lloyds case say? What did the judgment say about the legal requirement to equalise GMPs and how to do this in practice?
  3. What have the DWP and HMRC provided in terms of guidance? Both the DWP and HMRC have produced guidance on GMPs. This Insight provides the key details and assesses what they mean for occupational pension schemes.
  4. What should pension schemes be doing now on GMP equalisation? GMP equalisation is a daunting prospect for many. It doesn't need to be, with the full attention of trustees and employers, the right advisers in place and a project plan, each element can broken down.

This insight explains the equalisation problems that are inherent with GMPs. It will be useful for those who are new to this subject or for anyone wanting a refresher on this complicated topic.

Key points on what GMPs are and why they are unequal

Employers were able to 'contract out' in respect of the additional state pension

On 6 April 1978, the government introduced a second tier of state pension provision in addition to the basic state pension. This additional state pension was called the State Earnings Related Pension Scheme (SERPS). It was possible to 'contract out' of the benefits provided by SERPS. The ways to do this have changed from time to time, but for present purposes, we are concerned with the option that existed from 1978 to 1997 for employers to provide occupational pension schemes that included a promise to pay GMPs, in return for being able to contract out of SERPS.

GMPs are intended to replicate certain state benefits

GMPs are intended to replicate members' SERPS benefits to try to ensure that a member would not be worse off as a result of being a member of an occupational pension scheme which was contracted out of SERPS.

Working life for GMP purposes ends at age 60 for women and age 65 for men

GMP works out average earnings over the member's working life. Working life is defined as the period starting from the later of 6 April 1978 (i.e. when SERPS started) and the tax year in which they reach age 16 and ending at the tax year in which they reach age 60 for women but age 65 for men (GMP Working Life). This is where the inequality comes from.

GMPs are unequal for a number of reasons

A woman could accrue the same GMP as a man in a shorter time. This was designed to reflect a shorter working life for women. In addition, women's GMP becomes payable five years earlier (i.e. at age 60 compared to a man's GMP which becomes payable at age 65). This is further complicated because of how GMPs interact with the rest of their scheme benefits (the Excess) when pensions are revalued in deferment and increased in payment.

Anti-franking legislation adds another layer of complication

So-called 'anti-franking' legislation operates to prevent the member's Excess being used to satisfy the obligation to revalue the member's GMP during the interval between the member leaving contracted-out service and the GMP coming into payment.

What are the problems with GMPs?

What are the key elements of GMPs?

GMPs accrued between 6 April 1978 and 5 April 1997 for members of occupational pension schemes which were contracted out of SERPS.

The GMP was intended broadly to replicate the member's SERPS benefit to try to ensure that he or she would not be worse off as a result of having contracted out of SERPS [1].

A GMP is a career average benefit. It works out average earnings over the GMP Working Life and pays a pension in respect of them.

As outlined above, GMP Working Life is the period starting from the later of 6 April 1978 (when SERPS began) and the tax year in which the individual achieved age 16, and ending at the tax year in which they achieved:

  • age 60 for women; but
  • age 65 for men.

This reflected the former state pension ages and is the root of the inequality that is inherent in GMPs.

Most occupational pension schemes followed the state pension system in having unequal retirement ages for men and women (usually, but not always, age 60 for women and age 65 for men). Occupational pension schemes have since had to equalise benefits following a landmark equal pay decision of the European Court of Justice in 1990 [2].

However, the career average nature of the GMP benefit, and its interaction with the overall benefit payable by the pension scheme, makes GMP equalisation considerably more complicated than equalisation of most non-GMP benefits.

How is GMP calculated?

To understand why, we need to understand how a GMP is calculated. For ease of reading, the following simplified description uses words whereas the legislation uses formulae. This description only applies to GMPs accrued since 6 April 1988 [3].

To calculate the GMP, a scheme must:

  • take all the member's earnings that are pensionable for SERPS purposes;
  • revalue them up into today's money;
  • then divide that total by the length of the GMP Working Life. As a reminder, in determining the length of GMP Working Life, any part of it that falls before 6 April 1978 is ignored and there is a minimum length of 20 years.
  • This division gives the member's average annual earnings in today's money. That amount is multiplied is then by 20%, and the result is the GMP.

An example of a male and a female with the same date of birth, length of service and earnings

Female X

Date of birth 5 August 1955

GMP Working Life 5 August 1971 – 5 August 2015

GMP calculation ((Member's Total Earnings x Revaluation Factor) ÷ 44) x 20%

Example ((500,000) ÷ 44) x 20% = £2,272.72

Male Y

Date of birth 5 August 1955

GMP Working Life 5 August 1971 – 5 August 2020

GMP calculation ((Member's Total Earnings x Revaluation Factor) ÷ 51) x 20%

Example ((500,000) ÷ 51) x 20% = £1,960.78

Reasons why GMP is unequal

GMP working life, accrual and payment

1. Women have shorter GMP Working Life

As a woman's GMP Working Life is five years shorter than an equivalent man's (ending at age 60 instead of age 65), when a woman's total earnings are divided by the length of the GMP Working Life, the result will be bigger than it would be for a man who had exactly the same earnings history and date of birth. Dividing by a smaller number gives a bigger result.

2. Women have faster GMP accrual

Put simply, a woman can accrue the same GMP as a man in a shorter time.

There was logic to that: because a woman's working life was shorter, she needed to be able to accrue her GMP faster in order to get the same overall benefit.

3. Women's GMP becomes payable earlier

The problem is then compounded by the fact that the woman's GMP not only accrues faster, it becomes payable five years earlier, at age 60, whereas a man's GMP payment age is age 65. Again, this reflects the old state pension age.

4. If a women's GMP is postponed, it is increased

A woman's GMP would often be postponed (e.g. if her retirement age in the pension scheme was 65) but she is then entitled to an increase in respect of the postponement. The man's GMP comes into payment at 65 with no such enhancement.

Interaction between the GMP and the overall scheme benefit in producing further inequalities

It would seem from the above that the inequality in GMPs favours women over men, but that is not necessarily the case. This is because the GMP is not a standalone benefit; it is a guaranteed minimum to be compared against the (usually bigger) pension payable by the pension scheme.

At the point in time when the member ceased being in contracted-out pensionable service, the GMP simply underpins the main benefit. However, from that point on, the main benefit is divided into two separate elements of pension: the GMP, and the remainder of the pension above the GMP (i.e. the Excess).

5. Differences in revaluation and pension increase rates for GMP and Excess

These two elements are usually [4] increased differently, both in respect of:

  • revaluation during the period (if any) between leaving service and drawing a pension; and
  • increases due when the pension is in payment.

The increases payable on the GMP may be less generous than the increases payable on the excess. That is more likely to be the case in respect of increases payable after the pension starts to be paid, but it varies.

So, counterintuitively, giving somebody a bigger GMP could make them worse off, because the total pension is still the same; and by making the GMP bigger, one simply makes a larger proportion of the pension subject to the less generous pension increases.

6. Application of anti-franking legislation

It becomes even more complicated where there is an interval between the member leaving contracted-out service and the GMP coming into payment. So-called "anti-franking" legislation operates to prevent the Excess being used to satisfy the obligation to revalue the GMP during that interval. The operation of this legislation is notoriously convoluted and the details are beyond the scope of this Insight.

For present purposes, it suffices to say that the legislation requires an "anti-franking" test to be carried out at the commencement of payment of the GMP. As that test needs to be carried out five years later for men than for women, it adds to the potential for inequality. This element tends to favour men as, when the test is applied five years later, there is five years' more GMP revaluation to be protected by it.

What next?

The above is a simplified explanation, but it demonstrates that this is not a simple issue. It is the complexity in the benefit design that makes equalising GMPs difficult, not only in terms of doing the work, but even to identify what steps should be taken to redress the inequality.

The position in any particular pension scheme may deviate from the position set out above, but the above will apply to most pension schemes which were contracted out in the relevant period.