HM Treasury has recently issued a consultation paper on proposals designed to provide equal and fully inflation-proofed guaranteed minimum pension (GMP) entitlements for male and female members of public service pension schemes. Depending on the approach taken, the proposals could add between £1.5-£5bn (0.15-0.5%) to the combined liabilities of public sector schemes.

Background

GMPs earned in contracted-out occupational pension schemes between 1978 and 1997 are subject to special rules regarding increases in payment, which are broadly intended to ensure that GMPs are fully inflation-proofed (with inflation currently being measured by reference to CPI).

Under the GMP legislation, the occupational pension scheme is responsible for paying CPI-linked increases on GMPs accrued after 6 April 1988, up to a maximum of 3%. Where the member has pre-1988 GMPs, or where CPI exceeds 3%, the balance of the member’s GMP increases used to be provided via an increase to the member’s additional state pension (previously SERPS).

However, the introduction of the new single-tier state pension from 6 April 2016 has meant that members who reach state pension age after that date will not have any additional state pension entitlement, and therefore the old mechanism for delivery of full inflation-proofing for GMPs no longer works for these individuals.

Although this issue was identified in advance of the change to the new state pension, the Government declined to make any special provision for private sector schemes. In contrast, for members of public service pension schemes, a transitional period was announced, running to 5 December 2018, during which members reaching state pension age would be provided with full GMP increases (on all their GMP entitlement) from the scheme. The Government also indicated that it would in due course be consulting on what arrangements should be put in place at the end of that transitional period.

Interaction with equalisation

The immediate issue which prompted the consultation was the possible loss of GMP increases. The Government has clearly taken the provisional view that commitments made to public servants at the time that GMPs were first introduced in 1975, which required full indexation of public service pension entitlements, including GMPs, should be maintained (though there is a hint that this point is not settled beyond dispute as yet).

At the same time, it is also clear from the consultation paper that the Government sees the issue of indexation as being inextricably linked with equalisation of GMPs under public service pension schemes. GMPs are in themselves inherently unequal, because statute provides for them to be payable from different ages for men and women. Although there is a long-running debate as to whether there is a legal obligation on schemes to adjust benefits to remove the effects of this inequality, the Government has consistently maintained that equalisation must be achieved.

The paper states that under the old state pension regime, owing to the fact that the whole of the member’s public service pension (including the GMP) was indexed by reference to the same percentage as the member’s additional state pension, the member received (overall) a payment which was equalised for the effect of the GMP. Therefore, as well as the immediate loss of GMP increases, the switch to the single-tier state pension also means that public service pension schemes are faced for the first time with the problem of how to equalise benefits for the effects of the GMP.

Proposals

The paper sets out three possible policy options for resolving these twin problems:

  1. A “case-by-case” approach (estimated cost £1.5bn or 0.15% increase in liabilities). Under this option, individual calculations would be performed to assess whether the member’s combined state and public service pension entitlements are lower under the new system than they would have been if the old state pension regime had been retained. If they are, the scheme will calculate a top-up amount to reflect the loss of indexation on the additional state pension. (Any losses resulting from other aspects of the new state pension regime will not attract a top-up.) The calculation will then be repeated as if the member were of the opposite sex, to produce a second top-up amount. The member will actually be awarded whichever of the two top-up amounts is higher. This process would need to be undertaken every year and would place a substantial administrative burden on schemes.
  2. Continuing to provide full indexation of GMPs through the public service pension scheme (estimated cost £5bn or 0.5% increase in liabilities). This is simply an indefinite extension of the current transitional arrangements. Although administratively much simpler for schemes, it nevertheless would require schemes to continue to meet the legislative requirements around administration of GMPs, even though (because of the full indexation obligation) those requirements would have no effect upon the actual payment received by the member. This solution also ignores the fact that many members may be net gainers from the change to the new single-tier state pension, such that they would (effectively) be being compensated for a “loss” which they had not actually suffered.
  3. Conversion of the GMP (estimated cost £5bn or 0.5% increase in liabilities). The suggestion here is that GMP would be converted into ordinary scheme pension on a £1 for £1 basis, since this will ensure that the Government meets prior commitments to provide full indexation on public service pensions. The effect, and cost, is therefore the same as for option 2, and it has many of the same disadvantages, including the risk of over-compensating members. Although it will avoid the ongoing costs of administering GMPs in the schemes, public service schemes will still need to carry out a full reconciliation of scheme and HMRC records of GMPs before conversion can proceed. The paper mentions the possibility that conversion could proceed on an actuarial equivalence basis (ie. something less than a 1:1 ratio), but this is provisionally rejected on the basis that it may lead to the Government failing to honour the commitment to full indexation.

Other solutions are also touched on (eg. a time-limited extension to the transitional arrangements), although not discussed in detail. In addition, the paper recognises that some private sector schemes cross-refer to the public service pensions legislation on indexation of pensions, and so may be affected by the final policy approach which is adopted. Views are specifically invited on whether the Government should or should not take steps to avoid any such “read across” into private sector scheme rules. The consultation closes on 20 February 2017.

At first glance, none of the options presented in the paper are likely to be particularly appealing to employers, who we anticipate will be required to meet the lion’s share of the additional cost associated with implementing any of these proposals. Scheme managers likewise may be dismayed by the heavy administrative burdens associated with at least some of the approaches (such as the “case-by-case” calculations). Affected parties will need to consider whether they wish to make representations before the consultation process concludes.

It is also interesting to see that the Government clearly believes that it is valid to take into account the member’s state pension provision when assessing whether benefits provided under public service pension schemes comply with equal treatment requirements. Although this has a certain logic in relation to direct Government employees (since the Government is ultimately responsible for payment of both state pensions and scheme benefits), the reasoning is less compelling in respect of private sector employers who are participating in public service pension schemes as a result of New Fair Deal or similar arrangements.