In our January Review we reported that Angela Eagle MP, the former Pensions Minister, had issued a statement about the equalisation of Guaranteed Minimum Pensions which indicated that all schemes (not just those about to enter the Pension Protection Fund or the Financial Assistance Scheme) should look to equalise GMPs. Since then, the pensions industry has been waiting with baited breath for legislation clarifying how this should be done (and hopefully providing some practical assistance as to how to do it).
We now have a new Government and a new Pensions Minister (Steve Webb MP). However, with the new Coalition Government being kept busy attempting to reduce the nation’s budget deficit, there seems to be little appetite (or time) for it to turn its attention to addressing the thorny issue of GMP equalisation any time soon…
The problem with GMPs
GMPs are effectively a different form of notional scheme benefits3 , subject to their own legislative requirements, and are inherently unequal between men and women4. This is because GMPs are payable from a member’s state pension age (currently 65 for men and 60 for women) and accrue at different rates for men and women.
The confusion as to whether (and how) to equalise GMPs (not to mention the risk of getting the method wrong) is why most schemes and employers have generally left the issue of GMP equalisation well alone, instead ensuring that only main scheme benefits are equalised. This approach was based on one of two arguments:
- GMPs are not “deferred pay” like other pension benefits and therefore do not fall within the requirements of Article 141 of the Treaty of Rome on equal pay (which was interpreted by the European Court of Justice in Barber5 to extend to a requirement for occupational pension schemes to provide equal pension benefits for men and women).
- The discrimination in the structure of GMPs is objectively justifiable, because the inequality is derived from their origin in replicating state benefits which were themselves unequal.
Where does that leave us now? Do nothing or do something?
In the absence of any further guidance, statements or legislation from the new Government there remains no specific legal requirement for ongoing pension schemes to equalise GMPs. It therefore seems that a sensible approach for some schemes could still be to adopt a “wait and see” approach, at least until further guidance is available.
Unfortunately, this approach is impractical for those pension schemes which are in the process of being wound-up, or are the subject of a buy-in or buy-out of scheme liabilities with an insurance company. Trustees and employers of schemes in these circumstances will need to consider carefully what action (if any) should be taken to equalise GMPs. We have had involvement in various buy-outs over the last 18 months where trustees had to decide whether to adopt specific proposals put forward by insurers to deal with GMP equalisation at the buy-in stage or had to propose alternative methods, as there was a need to crystallise a solution and delay was not an option. This article focuses on what schemes in such a situation can do, rather than the continuing possibility of “wait and see” for ongoing schemes.
What are the options?
The Pensions Regulator’s guidance: Winding-up: avoiding delays (June 2008) stated that the Regulator:
“does not take a view on whether trustees should or should not equalise GMP benefits, nor on how they should be equalised. Instead we recognise that a range of approaches could be taken, depending on the scheme involved and the trustees’ view on the issues. We do not endorse any particular approach and trustees should, in consultation with their advisers, consider the options available to them and agree the best approach taking into account the characteristics and funding position of their particular scheme. An analysis of the costs and benefits of any approach should be carried out so as to ensure the agreed approach provides the best solution for members.”
The Regulator revised this guidance in June 2010 and notably removed all references to GMP equalisation, reportedly to prevent “potential inconsistency” between its guidance and the most recent position of the DWP, PPF and FAS. This essentially means that schemes not subject to PPF and FAS guidance are currently left to their own devices. The Regulator’s 2008 view echoed the view set out in Opra6 Update 3: Winding up issued in August 2003. In particular, Opra specifically stated that “although Opra does not endorse any particular method we consider that, with their advisers, trustees can arrive at a solution which is suitable for their scheme”.
We look at the most common options which have been considered by pension scheme trustees when faced with having to address the equalisation of GMPs.
- Do nothing
Because it remains unclear as to whether a requirement to equalise GMPs actually exists for pension schemes which are being wound up or are the subject of a buy-out – a “wait and see” approach may, in some cases, remain a viable alternative until benefits come into payment.
This is particularly the case where trustees are negotiating a buy-in policy with insurers, as they will not be under pressure to crystallise members’ benefits until the later buy-out stage. If GMP benefits need to be adjusted once the buy-in policy has been entered into, but before insurance policies have been bought out in individual members’ names, this can be done by way of an amendment to the buy-in insurance premium. If it becomes necessary to adjust members’ GMP benefits after those members have been issued with individual buy-out policies, the insurer will be required to adjust those members’ benefits in order to comply with the legal requirements regarding GMP equalisation. However, this route only works if all sides (including the sponsoring employer who will be footing the bill for equalisation at some stage) agree. If the buy-in policy contains a time limited option to buy out, the decision must be taken sooner or later.
- Augment members’ benefits to make a suitable allowance for GMP equalisation
We are aware of a wide variety of methods which have been adopted by schemes which decide to equalise GMPs, and indeed the Opra Update sets out a number of examples. Of course it goes without saying that different approaches will suit different schemes, depending on their circumstances.
On a recent buy-out where we were advising the trustees, the insurer proposed a method for equalising GMPs which involved what appeared at first sight to be a form of “franking”. Broadly, the insurer proposed that calculations be carried out on each member’s GMP as if they were a member of the opposite sex, and whichever calculation was the most generous would be taken to apply to that member, but with no change to the overall value of pension.
This interpretation of the nature of the GMP rested on the fact that it is a notional and not a separate distinct benefit from the main scheme benefit, ie it operated as an underpin by reference to the State benefit that was being covered. Initially, the trustees’ preference was to “wait and see”. However, following actuarial and legal advice, the insurer’s method was accepted by the trustees on the following grounds. First, it was argued that the “wait and see” approach could be criticised by aggrieved male members as an abrogation of the duty to act reasonably when a proposal which was not manifestly wrong was suggested to them (in other words, it was worse to do nothing than to do something). Second (and consequent upon the first ground) an undertaking was written into the policy that no member would be worse off as a result of adopting the insurer’s proposed method, so that if it did subsequently transpire that the equalisation method adopted was insufficient, any cost of rectifying the position would be borne by the insurer.
There is, as the above example shows, more than one way to skin the GMP cat.
Examples of other methods which have been proposed for equalising GMPs are:
- Treating the GMP and non GMP elements of members’ pensions separately. This method has the effect of being more generous and consequently more costly to provide, and care would need to be taken to ensure that it did not raise concerns as regards equalisation generally (there is a risk that females could end up with a lower benefit).
- Providing a discretionary increase on the tranche of benefits earned between the date of the Barber judgment (17 May 1990) and 5 April 1997. The risk with this method is that, whilst straightforward to administer, it may not be sufficient to equalise GMPs correctly.
- Notifying members that GMPs are unequal and requesting members to consent to the position. This is an option considered in the Opra Update which suggests offering to carry out an equalisation exercise at members’ costs – this may difficult on an administrative basis. It also suggests that members are capable of consenting to the continuation of inequality, which strikes us as a flawed legal proposition.
- Carrying out a comparison of member benefits on a year by year basis against the benefits that would have been payable had the member been of the opposite sex. This is again a suggestion made by Opra.
- Obtain an indemnity from the sponsoring employer – this is a variant on the “wait and see” approach and only works if the employer stays in business following the winding-up or the buy-out.
- Take out insurance policies to cover the requirement to equalise GMPs – if cover is available.
What factors should trustees take into account?
As we have already mentioned, both the Pensions Regulator, and Opra before it, recognised that there is no “one size fits all” method to equalise GMPs. Trustees are expected to explore the range of options available with their advisers and arrive at a method which is suitable, bearing in mind the peculiarities of their scheme and considering the impact not only on standard retirement benefits, but also on other ancillary benefits, the amount of which are partly dependent on the level of GMP (such as dependants’ pensions).
In deciding what option to take, trustees should reach a decision in accordance with their duty to act in the best interests of the members. The general principle is that, provided trustees take into account all relevant factors, disregard all irrelevant factors, and arrive at a decision which they believe to be in the overall best interests of their members, they should not be open to successful challenge. Indeed, in the context of a winding up, a decision concerning whether or not (or how) to equalise GMPs, which has been made in accordance with these principles, will not be invalidated at a later date if legislation is later changed to require equalisation of GMPs on a basis different to that which the trustees, acting reasonably, chose to adopt at the time. This is because hindsight over such decisions is not admissible.
In the context of a buy-in/buy-out, in deciding whether proposals which have been put forward should be adopted, trustees will need to strike a balance between adopting an approach which is too generous (ie too costly for the employer) or not generous enough (therefore exposing themselves to criticism from pension scheme members).
A relevant factor for trustees faced with a decision whether (and if so, how) to equalise GMPs will be the cost of the exercise relative to the perceived benefit to members, bearing in mind the funding position of the scheme. In our experience (and this is echoed by the Opra Update), the variations in members’ benefits caused by the differences in GMPs are often not significant and so the cost of a complex equalisation exercise may be prohibitively disproportionate. In the context of a buy-in/buy-out, if a decision is taken to equalise benefits as part of the process, there will be an impact on the price of the insurer’s premium. This was a relevant factor for the trustees in one recent buy-out we advised on, where the insurer had proposed a particular method for equalising GMPs as part of the buy-in process and had incorporated the cost of doing this into the premium. Consequently, if GMPs were not equalised (and the risk insured), or a different method was used, this would have involved additional calculations and undoubtedly an increase in the insurer’s premium. In the context of a pension scheme which is winding-up in deficit, unless the cost of the exercise is borne by the employer, this cost will reduce the assets in the scheme available to pay benefits (and ultimately to secure those benefits with an insurer).
Related to the issue of cost is the view of the employer and its appetite for the additional expense of equalising – these are additional factors that trustees can legitimately take into account.
There is nothing like legal uncertainty for paralysing the mind, and when the Government changes the rules in an unspecified way it is not surprising that most people will defer decisionmaking. However, there are solutions to equalising GMPs when action needs to be taken on a winding-up or buy-out. In such circumstances, trustees and employers should not shirk responsibilities to do the best they can to reach an equitable solution.