The High Court ruled in October 2018 that pension schemes with guaranteed minimum pensions (GMPs) are under a legal obligation to increase benefits where necessary, to remove the inequality in the way that GMPs treat men and women. Trustees have been left since then in a state of uncertainty over how - and when - to do that. It is clearly unsustainable that trustees are, every month, not paying pensioners their full entitlement, and the more time that passes, the more difficult it becomes.
This Insight sets out a pragmatic way for pension schemes to make progress on this, starting in this Autumn's trustee meeting with a review of the current position on GMP reconciliation and equalisation and the setting out of a project plan.
This Insight is the fourth in our new series of Insights on GMP equalisation. You can navigate between these Insights using the links below.
- 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.
- 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?
- 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.
Key action points for trustees
1. First things first
Most schemes in our experience have already done this or are well advanced, but an immediate action point for all schemes is to ensure that their data is in sufficiently good shape to enable GMP equalisation (including completing GMP reconciliation) and to equalise transfer values and full commutations.
2. Conversion or not?
This is the fundamental question which trustees and employers need to decide. The default way to equalise GMPs is to run a system of dual records, carrying out checks at every pension increase so that the overall amount received by the member and a notional comparator of the opposite sex would be the same. This is called "Method C2", and it is possible but administratively complex.
The alternative is to convert GMPs into non-GMP benefits which are of actuarially equivalent value, taking account of the need to equalise in that process. Conversion (also known as "Method D2") is an attractive option for many schemes, and can be done as a one-off project or when each member retires. It requires the employer's agreement. It does also have its challenges and risks.
There is no requirement to adopt the same approach for every member, so trustees might decide to use one method for one group and a different method for another.
3. Make a plan
Whether Method C2 or Method D2 is adopted, there will be some key commercial decisions which need to be made by trustees and employers – generally, these are the decisions as to what method will be used, and how benefits are to be reshaped. The more technical details can usually be left to advisers. Good project planning is essential to keep this project focused.
Will GMP equalisation go away on its own?
GMP equalisation is a product of anti-discrimination laws in both the European Union and the UK. Whilst the European dimension may (or may not) disappear at the end of the year, there has been no indication from UK policymakers that they intend to exempt pension schemes from this obligation.
Whilst in most cases, GMP equalisation does not result in life-altering changes to any individual's entitlement, there are some cases where it does make a significant difference. Even where the differences are minor, a trustee's most basic obligation is to pay the correct benefits in accordance with their trust deed and overriding law.
If the UK Parliament is not going to change the law, it falls to schemes and their advisers to bring benefits into line with the law, but in a pragmatic way that keeps the costs proportionate to the benefits.
What free help is available?
Since the original Lloyds judgment was handed down, its implications have been clarified – to varying degrees of helpfulness – by the courts, HMRC, the DWP and industry working groups. The most recent was further HMRC guidance, issued in late July.
The "GMP Equalisation Working Group", under the banner of the Pensions Administration Standards Association (PASA) is publishing a suite of guidance notes free of charge. We also have guidance from HMRC and DWP. This means that schemes only need to pay advisers to consider whether these recommendations are suitable for their schemes, and to consider the more difficult issues. It is not necessary to pay advisers to consider every issue from first principles.
The industry now has pretty much all the help we are likely to get. There is some further support still to come, including a further court ruling about who is responsible for topping up past transfer values, and further guidance from the GMP Equalisation Working Group. None of those remaining pieces are expected materially to alter the industry's understanding of what the issues are and what tools are available to resolve them.
The autumn is therefore the time to be planning how to comply with this legal obligation. The existence of industry-wide guidance, which is all freely available and free of charge, will make the process less onerous.
Get the priority tasks out of the way
The top priority is to ensure that the data is available for GMP equalisation to be carried out accurately. This includes completing the reconciliation of GMP data with that of HMRC, and considering the consequences of that for the rectification of benefits.
On the latter point, a decision needs to be made as to the timing for making the required changes to benefits following GMP reconciliation (known as "GMP rectification"). Trustees should consider whether there are any groups of members for whom corrections should be made without further delay (perhaps current pensioners, or those unaffected by GMP equalisation), or whether rectification can wait and be done at the same time as any changes required due to GMP equalisation.
Equal first priority also goes to the need to equalise GMPs for people who are taking all their benefits out of the pension scheme in one go – i.e. transfer values and full commutations. In our experience most schemes are now paying these on an equalised basis. Unless exceptional circumstances apply, we consider that all schemes should now be adopting an equalised approach to transfer values and full commutations. Indeed, the July guidance from HMRC suggests that schemes could be getting themselves into more difficulty if they do not do this.
To convert of not to convert?
The biggest decision is whether or not to convert GMPs into non-GMP benefits of equal actuarial value. Legislation already exists to enable this conversion. At a conceptual level, it is simple to add equalisation into the process of converting benefits – the scheme puts an actuarial value on the benefits including the GMP, uplifts that actuarial value if it would have been higher if the member were of the opposite sex in the period after the duty to equalise came into effect, and then converts that actuarial value into a simpler benefit design that does not involve a GMP.
To answer the question we posed, of how to make GMP equalisation go away, conversion is therefore appealing. It enables equalisation to be dealt with as part of a single, one-off exercise. (We will question below whether that is actually as desirable as it sounds.)
Furthermore, conversion not only enables compliance with the duty to equalise GMPs, it has a positive advantage in its own right, by simplifying the benefit design. It can also be combined with member options exercises in order to facilitate a funding advantage.
Although it is conceptually simple, conversion throws up a number of technical challenges, mostly involving tax. Schemes that are considering conversion will need their advisers to explain to them in plain English what those challenges are, and how they may be surmounted.
Conversion can only be used with the consent of the employer. Also, it is possible for trustees to decide to use one method for one group, and another method for another. This is something trustees will need advice on in order to fit the specific circumstances of the scheme.
What to convert into?
If conversion is adopted, the trustees need to determine the shape of the converted benefits.
We expect that in most cases, trustees will not want to deviate too far from the existing benefit design. As well as achieving equalisation, however, conversion can remove or simplify some of the more administratively problematic aspects of GMPs – a good example is the so-called anti-franking rules, which are notoriously complex.
Whilst a radical reshaping of the benefits is theoretically possible, we expect trustees to be reluctant to do this because conversion is forced on members without their consent (they must be consulted, but they cannot refuse to be converted). A radical reshaping into a benefit design of equal actuarial value will create winners and losers, because even though a benefit may be of equal actuarial value, to a real-life individual it will alter the amount he receives over his retirement.
When to convert deferred members?
If conversion is adopted, the trustees need to determine whether to convert all deferred members and pensioner members as a one-off exercise, or whether to convert pensioners as a one-off exercise but only convert deferred members as they reach retirement.
Part of the appeal of conversion is that it enables equalisation to be over and done with, as a single exercise. However, the possibility of converting deferred members on an individual basis when they reach retirement should not be ruled out, for two reasons.
First, it reduces the uncertainty in the actuarial calculations, meaning that the post-conversion benefit is less likely to be materially better or worse for the member than the pre-conversion benefit.
Second, it avoids some of the trickier technical issues that arise with conversion in relation to tax.
How to weigh those advantages against the appeal of a one-off exercise is a point which trustees should discuss with their advisers – the answer will not be the same for all schemes.
Alternatives to conversion
If conversion is not adopted, the default way to equalise GMPs is the so-called "Method C2" from the Lloyds legal case.
This involves continual adjustment to the pension over the lifetime of the pensioner to ensure that at any given time, the cumulative amount actually received by the pensioner is at least as much as he or she would have received had he or she been of the opposite sex from the date when the duty to equalise came into effect. In calculating that cumulative amount, adjustments are made to reflect the time value of money.
It is a complicated method and requires dual administrative records for each member, so that the comparisons can be made. As such, it is likely to be relatively expensive and may increase the risk of administration errors.
However, the mainstream third party administration service providers are all developing this capability for schemes who wish to use it.
Simpler and more member-friendly methods also exist, but in most schemes these would require the agreement of the employer as they are effectively augmenting the benefits.
The fact that the market is now ready to deliver pretty much any reasonable method of GMP equalisation means that trustees can make the big decisions on the choice of method, having considered the advice of their actuarial and legal advisers, and leave it to their service providers to implement them.
Correct existing pensioners
Existing pensioners present two distinct but related questions: how to correct their pension for the future (for which the above considerations apply), but also how to correct the instalments of pensions they have already received.
As well as the technical question of how the solutions adopted for the past and the future interact with each other, this aspect is likely to include the need for legal advice on whether historic underpayments, or part of them, can be regarded as forfeit under the scheme rules (i.e. non-recoverable by the member due to the passage of time). This question will require analysis of the scheme rules and careful thought regarding the position of members and the employer.
GMP equalisation involves many difficult technical challenges, and we have spared the readers of this note too much detail of these. Nobody intended the present situation to arise: the difficulty stems from the unpredictable interaction between the UK Government's rules for contracted-out pension schemes and the European court's interpretation of the requirement for equal pay for equal work between the sexes.
It is therefore vitally important that trustees and employers do not get lost in the weeds of this issue. It is important because there are so many weeds in which one could get lost.
To manage this risk, trustees need to distinguish between the following types of decision.
- Key commercial decisions which require decision-maker input. These are the decisions which affect the benefit design or scheme funding – for example, the decision on whether or not to use conversion, the shape of the benefits after conversion, and the decision on whether to exercise any discretionary power that may exist to treat historic underpayments as forfeit.
- Technical legal or actuarial points. There are numerous questions that require a decision, but where that decision is of a technical nature it is unclear how best to ensure compliance. On these, trustees should press their advisers to take a position and stand behind it. It is reasonable for trustees to be able to expect to rely on their advisers to confirm the best approach to technical points.
- Practical implementation points. Once the decisions have been made, they need to be implemented. Trustees should be able to rely on their third party service providers for this, whether that is an outsourced administration services provider or an in-house pensions administration team.
Advisers can help trustees to make the above distinctions. Ensuring that trustees only need to get involved in category 1 decisions will do much to make this a much more tolerable exercise for them.
Obviously in real life there will be a degree of overlap between the categories, and for many trustee boards, it may be more efficient to delegate the management of this project to a sub-committee comprising trustees and advisers, with the full Board only being involved in the crucial category 1 decisions.
We recommend that a comprehensive project plan be agreed at the outset, showing the actuarial, legal and administrative workstreams, and identifying the key decisions in accordance with the above categorisation.
GMP equalisation will only go away when trustees address it, and they need to do so in order to be compliant with their legal duties. If handled well, the project can have some upsides, in the form of benefit simplification and liability management.
There is now sufficient knowledge and capacity in the pensions industry for this project to move forwards. Once data is in good shape and immediate settlements have been equalised, the project planning for the more challenging task of equalising pensions payable out of the scheme can begin.
The first step is to put in place a good project plan, and the forthcoming autumn round of trustee meetings is a good time to get this underway.