Since the judgment in Lloyds last year, trustees, employers and pension professionals have been awaiting guidance from the Department for Work and Pensions (the DWP) on the use of Guaranteed Minimum Pensions (GMP) conversion legislation. Late last week, the guidance was published.
In the first part of our Insight, we set out a summary of the key points and issues arising from the DWP's Guidance on the use of the Guaranteed Minimum Pensions (GMP) conversion legislation (18 April 2019) (the Guidance) on the use of the GMP conversion legislation. This Insight does not:
- explain why GMPs create inequality in overall scheme benefits (see our Insight GMP equalisation - what is the problem with equalisation); or
- unpack the Lloyds decision (see our Insight GMP equalisation - what now for trustees and employers).
Unsurprisingly, the Guidance does not give all the answers on GMP equalisation. Instead, it should be seen as a step towards the ultimate destination, but with a lot of work to do to get there.
The second part of our insight sets out what trustees and employers need to consider on when and how to equalise GMPs and what actions they can be doing now to move forward on equalisation projects.
Nine key points from the Guidance
1. No single method for equalisation
The government has not asserted that there is a single method that will be appropriate for all schemes in order to equalise benefits for the effect of GMPs. The Guidance simply puts forward one possible method for equalising benefits.
2.Trustees will need to take advice and make decisions
It is for the trustees of each scheme to decide the methodology that is most appropriate for their scheme, having taken advice.
3. The DWP has proposed a method which uses the conversion legislation
For the purpose of equalisation, this method:
- places an actuarial value on benefits accruing between 17 May 1990 and 5 April 1997;
- takes the higher of the value of a member's benefits and the value it would have been had the member been of the opposite sex during the period; and
converts this higher value into benefits that are no longer subject to the (unequal) requirements of the GMP legislation.
4. DWP have provided a step process for conversion
Should trustees decide to purse the conversion route, the Guidance sets out a 10 stage process.
5. Past arrears are not dealt with in the Guidance
The method set out in the Guidance does not deal with the past arrears due to pensioners. This is a difficult area and one in which legal advice will be needed (especially if conversion is the chosen equalisation method for future instalments).
6. The methodology will result in scheme amendment
Under the DWP's methodology, a scheme is amended so that it no longer contains benefits subject to the GMP rules in respect of some or all members with GMP entitlements.
7. All GMP and the benefit which accrued alongside will need to be converted
For a selected member, all of their GMP and the benefits which accrued alongside this GMP need to take part in the conversion process, not just those relating to accrual between 17 May 1990 to 5 April 1997.
8. Trustees do not need to convert GMPs for all members
The employer and the trustees can decide which members will have their benefits converted. The Guidance provides an example of deferred and pensioner members being converted first, and then waiting until the active members become deferred members before converting their benefits.
9. A number of points remain unresolved
The Guidance does not cover all of the questions that have been asked by the pensions industry. For these issues, trustees will need to take advice and/or wait for further guidance.
What is the aim of the Guidance?
The Guidance describes how schemes could use the GMP conversion legislation to achieve equality going forwards but it is important to note that the method described in the Guidance is not the only possible way of effecting equalisation and it should not be seen as prescriptive.
What is not covered in the Guidance?
The DWP is not:
- placing any obligation on schemes to use the method described in the Guidance;
- providing advice to schemes on how to equalise; or
- providing a definitive statement of how equalisation should be effected.
What is the relevance of the Guidance?
Following Lloyds, conversion of GMPs has been seen as one of the more attractive ways of addressing GMP equalisation. As a result, the Guidance is likely to be of interest to most trustees. Even if, in the end, trustees decide not to adopt the DWP's approach to equalisation, they will need to understand all of their options.
In a nutshell: how does the DWP methodology work?
The DWP method:
- places, for the purpose of equalisation, an actuarial value on benefits accruing between 17 May 1990 and 5 April 1997;
- takes the higher value of a member's benefits and the value it would have been had the member been of the opposite sex during the period; and
- converts this higher value into benefits that are no longer subject to the (unequal) requirements of the GMP legislation.
The scheme is amended so that it no longer contains benefits subject to the GMP rules in respect of some or all members with GMP entitlements. The result is that the GMP rules, which create inequality between the sexes, are removed for the relevant members going forward.
More detail on how the DWP methodology works
Before trustees start resolving inequalities, it is important that they are satisfied that they hold the correct GMP figure. The Guidance sets out a 10 stage process which results in an adjustment to an individual's benefits to compensate for post 16 May 1990 GMP inequalities as well as conversion of all of the individual's GMP. The 10 stages of the process for resolving GMP inequalities through GMP conversion are summarised below.
Stage 1 - Reach agreement with the employer
The trustees agree with the employer that GMP conversion is to be undertaken and the terms on which benefits are to be converted as part of the conversion exercise (see stage 2).
Agreement has to be with the employer in relation to the scheme. This means that where the participating employers have changed over the years, legal advice will be needed as to how (or whether) the consent requirement applies.
Stage 2 - Select the members for conversion and agree which benefits are to be converted and the form of the new benefits
In practice there are three elements to stage 2:
It is not necessary to convert benefits for all members, nor to convert at the same time. Therefore, the trustees and the employer need to identify and agree which members will have their benefits converted. Members who trustees and employers may want to consider including in the conversion process are:
- those members with service between 17 May 1990 and 5 April 1997, even if no equalisation uplift is required;
- survivors in receipt of GMP survivors' pensions following the death of a previously contracted out member; and
- members who left active service before 17 May 1990 (but for them there will be no need to undertake an equalisation step).
Agreeing the benefits to amend as part of the conversion process
The trustees and employers will also need to decide which benefits will be amended as part of the conversion process. The trustees are required to remove the GMP rules relating to the selected members.
For pre-1990 service, the Guidance explains that it is not necessary to reshape either the GMP or the excess, as both can remain unequal.
The Guidance does, however, make it clear that for a selected member, all of their GMP and the benefit which accrued alongside this GMP need to take part in the conversion process, not just that relating to 17 May 1990 to 5 April 1997 accrual.
Deciding the form of the post conversion benefits
A decision regarding the form the post-conversion benefits will take will also be required. The form of these is constrained by legislation. In particular, the post conversion benefits:
- must be actuarially at least equivalent to the pre conversion benefits;
- must not include money purchase benefits, apart from those provided under the scheme immediately before the conversion date;
- must include survivors' benefits in accordance with legislative requirements;
- for pensions in payment, the amount of pension to which a member had an immediate entitlement before the conversion must not be reduced as a result of the conversion.
Because of the legislative constraints on the form for the post-conversion benefits, this is an area in which trustees will need specific legal advice.
Stage 3 - Set the conversion date
The trustees and the employer agree the date at which conversion is to be effected (the "conversion date").
Stage 4 - Pre-conversion consultation
The trustees need to write to the selected members to inform them of the proposed conversion and seek their views. Trustees are required to take all reasonable steps to consult members. Consultation should be at a high level. The Trustees will be required to send more personalised information once calculations have been concluded and benefits adjusted.
Stage 5 - Valuation
The trustees then need to instruct the scheme actuary to value for each selected member an amount A and amount B:
Amount A - this is the member's benefits to be converted (along with attaching survivor benefits) - typically those in respect of that part of pensionable service up to 5 April 1997 during which the GMP that is being converted accrued. Amount A is effectively the pre conversion, pre GMP equalisation value of these pre 1997 benefits.
Amount B - this is the member's benefits (along with attaching survivor benefits) in respect of the same part of pensionable service (so typically up to 5 April 1997 during which the GMP that is being converted accrued), but assuming that for the period from 17 May 1990 to 5 April 1997 the GMP entitlement had been calculated as if they were of the opposite sex, with the excess over GMP being adjusted accordingly.
Both amounts A and B need to be calculated as at the conversion date and on the same basis.
It will be necessary to value and compare the whole (non-money purchase) benefit accrued in the selected period, not just the GMP, because members with a higher GMP will have a lower excess over GMP.
The trustees are responsible for determining the actuarial equivalence of the pre and post conversion benefits. In doing so, they must arrange for the scheme actuary to calculate the actuarial values of the pre and post conversion benefits.
The trustees are required to obtain and consider advice from the scheme actuary in deciding what assumptions are appropriate. The Guidance points out that the choice of approach may substantially affect some members' benefits, in particular where benefits increase at different rates pre and post conversion.
The Guidance says that the scheme's cash equivalent transfer value (CETV) basis will often be an acceptable starting point for a basis to calculate amount A and B. Points which will require consideration include:
- whether the current CETV basis should be reviewed;
- the use of assumptions which are non-unisex;
- the state of the pension scheme's data in respect of pensioners;
- how to 'roll back' the pension to when the individual left pensionable service (if this is required); and
- how to value benefits for active members.
Stage 6 - Equalisation
The trustees adjust for the effects of unequal GMPs by using a conversion value for each selected member: this is the higher of amount A and amount B from stage 5 above, so the more valuable of the male or female benefit structure.
Stage 7 - Conversion
Determining the post conversion benefit: once the conversion value for the selected member has been determined, this forms the budget from which new benefits are costed to replace those benefits in which is GMP accrued. So this amount is turned back into a revised pension benefit. A consistent approach to the Stage 5 valuation should be used. For pensioners, the conversion approach only assesses the effect of GMP equalities from the conversion date- the trustees will need to use another equalisation method to deal with past payments.
Stage 8 - Certification
The actuary needs to certify that the calculations have been completed and that the post conversion benefits are actuarially at least equivalent to the pre conversion benefits as equalised for the effect of GMPs. The certificate must be sent to the trustees no later than 3 months after the calculations have been completed.
Stage 9 - Modification of scheme to effect conversion
The trustees need to choose how to effect conversion. They may use:
- the statutory power to resolve to effect the conversion on the agreed basis; or
- the scheme's amendment power to enable GMP conversion, in which case Sections 67 to 67I of the Pensions Act 1995 are disapplied.
Stage 10 - Post conversion notifications
The trustees must take all reasonable steps to notify the members and survivors (in the latter case, those with an immediate entitlement to benefits) whose benefits have been converted either in advance or as soon as reasonably practicable after the conversion date. At this stage, members and survivors should be told what this means in terms of the amount and the shape of the benefit going forward.
HMRC also needs to be notified on or before the conversion date that the individual's GMPs have been or will be converted.
Where does the Guidance leave trustees and employers?
The Guidance does not answer all the questions but it gives a clear framework which trustees can use to engage with employers and start seeking appropriate actuarial and legal advice.
As the Guidance notes, there are a number of unresolved issues. These include:
- Pensions tax issues - HMRC has already said that it will provide more information and guidance on this in the coming months.
- Which employer needs to agree to the conversion of GMPs (an issue that will be especially relevant for schemes with complicated histories).
- How to deal with GMP underpins in defined contribution schemes.
The Government is considering changes to the GMP conversion legislation to clarify certain issues and the Guidance will be updated from time to time to reflect any changes to legislation that take place.
What next for trustees and employers?
Trustees and employers need to consider:
- when to equalise GMPs - do they need to take action now or can they await further developments; and
- what actions they can take now to lay solid foundations for equalisation projects.
The second part of our Insight looks at these considerations in more detail and what is next for trustees and employers.