The DWP has published its consultation response to the proposed new regulations implementing the conversion of Guaranteed Minimum Pensions (GMPs) to normal scheme benefits of actuarial equivalence. Schemes will be able to convert GMPs with effect from 6 April 2009. However, two main deterrents remain: the requirement to provide survivor benefits post-conversion and the fact that many schemes have not yet equalised GMPs between the sexes.
Between 6 April 1978 and 5 April 1997, occupational defined benefit (final salary) pension schemes were able to contract out of the state second pension, formerly known as SERPS. This was achieved by promising to provide pensions, known as guaranteed minimum pensions (GMPs), that were no lower than the level of benefits then specified in legislation. These benefits were guaranteed at a minimum level based on the amount the pensioner would otherwise have received under SERPS. Members of contracted-out schemes were able to forego their state second pension and instead could be provided with minimum benefits under their employer’s pension scheme. Both members and employers then paid lower national insurance contributions if they participated in a contracted-out scheme. GMPs ceased to accrue from 6 April 1997.
From 6 April 1997, the Government sought to simplify the process for contracting-out of the state second pension. After this date, schemes were able to provide benefits on a contracted-out basis as long as they provided benefits which were “better than” or “broadly equivalent to” the benefits set out under the statutory standard of a notional “reference scheme”. Thus a scheme could contract out of the state second pension if it passed the “reference scheme test”. To satisfy this test, scheme benefits must accrue at the stipulated rate and the scheme must provide a 50 per cent pension for surviving spouses and civil partners. Satisfaction of the reference scheme test must be certified by the scheme’s actuary. However, no simplification was introduced to deal with past service benefits, so many schemes have historic GMP liabilities.
The GMP legislation is complex as it sets out different increase levels, revaluation provisions and calculations for dependants’ pensions in comparison to those applicable to other “non-GMP” benefits under a contracted-out scheme. Furthermore, since GMPs mirror state scheme benefits and are therefore payable from state pension scheme age, there are equalisation issues. GMPs require complex administration and have to be calculated and recorded separately from the scheme’s main benefits to ensure that the GMP promise is met.
The Pensions Act 2007 sets out new enabling provisions permitting the conversion of GMPs to other scheme benefits, provided that actuarial equivalence is achieved. In this briefing we will examine in detail the Government’s proposed regulations governing GMP conversion which are due to come into effect on 6 April 2009, and the conditions which schemes need to satisfy before embarking on the conversion process. We will also look at the main deterrents affecting possible GMP conversion - the requirement to provide survivor benefits post-conversion and the fact that many schemes have not yet equalised GMPs between the sexes.
In January 2009, the Department for Work and Pensions (DWP) published its response to its September 2008 consultation exercise on the draft regulations. The new regime will allow for GMPs to be converted into ordinary scheme benefits on the basis of actuarial equivalence. No major changes are to be made to the draft regulations following the consultation process and the regulations are due to come into force on 6 April 2009.
The intention of the proposed regulations is that by converting members’ GMPs into scheme benefits, schemes will subsequently no longer need to track and monitor GMPs separately. The DWP’s rationale is to reduce scheme administration costs in the long term and to assist members’ understanding of all their pension rights. In addition, in order to effect GMP conversion, trustees will be able to amend the relevant rules in their scheme documentation by resolution and without the usual application of procedures under section 67 of the Pensions Act 1995, which would otherwise bar trustees from making any amendments to the scheme that would have a retrospectively detrimental effect on scheme benefits.
Under the new regime, GMP conversion can be carried out at any time. It may be effected in respect of an individual member, a group of members or all members of the scheme. There is no limit on the number of conversion exercises a scheme may undertake, so members’ GMP benefits may be converted in tranches over many years. Additionally, a scheme may convert GMPs either when it is ongoing or when it is winding up.
Statutory conditions for conversion
The Pensions Act 2007 introduces five conditions that need to be satisfied before GMPs can be converted:
Condition 1 – actuarial equivalence
Post-conversion benefits must be actuarially at least equivalent to pre-conversion benefits. Having taken actuarial advice, the trustees must determine the appropriate assumptions for use in the actuarial equivalence calculation, in advance of the conversion date. If conditions (for example, financial circumstances) then change significantly before the conversion date, the assumptions may be revisited. It is also for the trustees to choose the conversion date itself
. The actuary must calculate the actuarial value of post-conversion benefits and certify that the post-conversion benefits are at least actuarially equivalent to the pre-conversion benefits. Equivalence need only be established on the conversion date - it is not a continuing requirement. In his calculations, the actuary should ignore discretionary benefits that may arise in the future, benefits exchanged for cash or forfeited and benefits due to be paid before the conversion date. Calculations must be carried out on a member by member basis.
Condition 2 – no reduction of pensions in payment at the conversion date
When a pensioner’s GMP is converted, the trustees must ensure that the pension in payment at the conversion date is not reduced.
Condition 3 – no money purchase benefits to be included in post-conversion benefits
Post-conversion benefits must not include any money purchase benefits. Conversion cannot be used to change a defined benefit scheme to a defined contribution (money purchase) scheme.
Condition 4 – survivors’ benefits
Survivors’ benefits must continue to be provided after the conversion. The requirement to provide for a survivor benefit post-conversion has been retained because the DWP is concerned that the removal of this requirement could give rise to human rights claims. Schemes will therefore need to mirror the survivors’ benefits required under the GMP legislation:
- 50 per cent of the entitlement from 1978 to 1997 for a surviving spouse; and
- 50 per cent of the entitlement from 1988 to 1997 for a surviving spouse or civil partner.
Condition 5 - procedural requirements
There are a number of procedural requirements that schemes must meet:
- the employer must consent to the conversion in advance (except where the scheme is in winding-up);
- the trustees must take all reasonable steps to consult members in advance (unless the scheme is winding-up) and the members must be given an opportunity to make representations to the trustees (the legislation does not define “reasonable steps”);
- the trustees must notify all members of the conversion in advance or as soon as possible after the conversion date; and
- HMRC must be notified on or before the conversion date.
Once the requirements have been satisfied, the scheme is discharged from an obligation to provide GMPs. The conversion guide attached to the regulations (and provided at Annex C of the DWP’s consultation document) suggests that trustees may wish to provide individual example calculations to members, although the legislation does not require this. However, the reconciliation of GMP records with the National Insurance Contributions Office, which the DWP does expect to be done, is likely to add costs to the conversion and cause additional delays.
Issues relating to the transfer of benefits
Once a scheme has converted its own GMPs, trustees and employers are unlikely to be willing to accept a future transfer of benefits including GMPs into the scheme. This may require a change to the scheme rules.
Although the Pensions Act 2007 would permit regulations to impose conditions on benefits subsequently transferred out of a scheme which has converted its GMP benefits, the DWP has decided against imposing such restrictions. This is illogical since the requirement to provide survivors’ benefits will not apply to the scheme receiving the transferred benefits. The survivors’ rights to such benefits may therefore be lost on transfer, although the converted scheme would, in contrast, still have to provide them.
The Barber decision and GMP equalisation
In the landmark case of Barber v Guardian Royal Exchange, the European Court of Justice confirmed, on 17 May 1990, that pensions payable under occupational pension schemes were “pay” under European law and that therefore pension benefits under those schemes had to be equal for men and women. However, there have been conflicting opinions following the Barber decision as to whether or not post-17 May 1990 GMPs need to be equalised. Arguments against equalisation include:
- they are a replacement for state benefits (which do not need to be equalised); and
- they are merely calculation factors in the overall pension.
The Pensions Ombudsman held in 2000 that GMPs should be equalised. However, this decision was overturned by the High Court on a jurisdictional issue only (relating to lack of representation for affected members), effectively leaving no High Court decision on GMP equalisation.
Equalisation is not a pre-conversion requirement under the legislation. However, the conversion guide annexed to the DWP’s original consultation document suggests that conversion does not relieve trustees of the need to equalise. Confusingly, the DWP’s consultation response issued in January 2009 reiterates its view that the GMP is not a separate pension and thus does not have to be separately equalised. Such uncertainty is likely to leave trustees and employers wary of the value of undertaking the conversion process.
To further confuse matters, the Pension Protection Fund (PPF) has taken the view that GMPs ought to be equalised when a scheme enters an assessment period. The PPF’s consultation ended on 28 June 2008 and its response is still awaited.
The Pensions Regulator
The DWP has rejected a “clearance” role for the Pensions Regulator (TPR) on GMP conversions. TPR will not monitor conversions, nor will it oversee the process or the results. If the decision has been taken to effect GMP conversion, it is for the trustees or scheme managers and their professional advisers to ensure that all the legislative requirements are met. TPR will only consider the use of its powers in “very extreme” circumstances, although those powers do include the possibility of ordering trustees to correct any deficiencies in the conversion process or even to declare the whole process void if it fails to comply with the legislation.
The conversion guide confirms that members may complain to the Ombudsman about the conversion process where, for example, they have a dispute of fact or law or believe that they have suffered injustice as a result of maladministration.
Will schemes convert?
At first glance, converting GMPs seems a good idea but in reality the costs of implementing GMP conversion may not be rewarded sufficiently by lower future expenses which justify the upfront costs of the change. The requirement to provide survivors’ benefits will mean converted GMPs still need to be tracked separately from other scheme benefits, which will reduce savings. The conversion process is unnecessarily complex and will, in all probability, be far more expensive than the estimates set out in the consultation document - £7,000 for a small scheme rising to £12,000 for a larger scheme.
The fact that most schemes have not equalised GMPs to date and that confusion exists over whether a GMP needs to be equalised before it can be converted may be a sufficient deterrent in many cases. Actuaries have also commented that there is a lack of clarity on how to calculate actuarial equivalence of pre-and post-conversion benefits.
It is unlikely that many schemes will be quick to take up conversion of their GMPs. It may also be more likely for a scheme to convert when its GMPs have already been equalised, when it is in winding-up or when conducting individual GMP conversions to facilitate transfers out.