This week the government published its latest proposals on guaranteed minimum pensions equalisation. And there’s good news and bad news for trustees and sponsors.
On the one hand the government has reaffirmed that it does expect schemes to equalise GMPs. This has been the government’s stance for some time, but the task is something of a headache for trustees, especially as many are still struggling with GMP reconciliation.
This is also unwelcome news for contracted out sponsors who will see tens of billions of pounds added to their pension liabilities.
But on the other hand, the equalisation method proposed in the latest consultation is less generous than the one outlined in an earlier 2012 consultation. It is also in line with the method already used by many schemes when equalising ahead of a buyout, which will come as a relief to insurers and former sponsors who might otherwise have had to pay out more.
Overall, he proposed method is a fair one and the best of a bad bunch
“While it’s bad news for companies – and potentially imposes a large cost on them – overall we think the proposed method is a fair one and the best of a bad bunch,” says Willis Towers Watson senior consultant Sally Minchella.
What is GMP equalisation?
A GMP is the minimum pension a scheme has to provide for those employees who were contracted out of the additional state pension, and therefore paid lower national insurance contributions, between 1978 and 1997.
This amount is broadly equivalent to what the member would have received from the additional state pension. Increases to this portion of a member’s pension are therefore calculated in a different way to the rest of their benefits.
Schemes must equalise GMPs accrued between 1990 and 1997 after the European Court of Justice ruled in the 1990 Barber case that schemes must pay equal benefits to comparable men and women in relation to service from that date.
While most schemes implemented the requirements by equalising benefits between men and women, almost no schemes tackled the inequalities that existed in GMPs. Gender inequality was inherent in this tranche of benefits, because it mirrored the state pension, which had different rules for men and women.
But the government has made it clear that schemes cannot continue avoiding this task.
“This consultation reaffirms the government’s view that GMP equalisation is necessary, although it stops short of legislating to require equalisation itself or a particular method,” says Minchella.
She also points out that the government’s view is based on complying with EU law and the consultation does not state whether this will be affected by Brexit. The default position, though, is that it will continue to hold, unless the UK government chooses otherwise.
Based on the experience of clients who have equalised GMPs ahead of a wind up, Minchella says the government’s preferred methodology will add 1-3% to scheme’s liabilities. At the low end of this estimate, this will equate to an increase of approximately £20bn across all contracted out schemes.
The timing of this project could also be problematic says Hymans Robertson head of corporate consulting Jon Hatchett.
The government is already creaking under the weight of queries
“One of the core building blocks that will enable equalisation to take place is GMP reconciliation. The government is already creaking under the weight of queries,” he says. “There is currently an eight-month backlog to process GMP data at HM Revenue and Customs, and it’s getting worse not better. This is already going to increase administration costs for trustees.”
Hatchett believes this should have been the government’s priority at present.
Jargon buster: GMP reconciliation
This is the process of ensuring a scheme’s records agree with those of the National Insurance Contribution Office, part of HMRC. Since the end of contracting out, HMRC is reducing its support of schemes, and will not be dealing with any queries after December 2018.
But Barnett Waddingham head of pensions research Tyron Potts says schemes will welcome the new guidance.
“The DWP’s proposed method is a pragmatic improvement on the so-called ‘Jack and Jill’ methodology proposed by the previous government, and in particular we expect the new approach will typically lead to smaller overall increases in scheme’s liabilities than under the 2012 approach,” he says. “Furthermore, the new approach should be less complex to implement and considerably simpler to administer going forward.”
Willis Towers Watson’s Minchella adds that the government’s simplified method tallies with that used by clients who have equalised GMPs ahead of a scheme wind-up.
All of our recent buyouts have used broadly the method proposed
“All of our recent buyouts have used broadly the method proposed by the consultation,” she says. “However, they have been left with the residual risk that the government could propose an alternative method (increasing liabilities after the trustees have used all of their assets on the insurance policy) and have typically insured against this.”
The consultation provides clarity and comfort to schemes in this situation and reduces that risk. Minchella also urges schemes to take advantage of this opportunity to simplify their benefit structures by converting GMPs at the same time has they equalise. This one-off adjustment would allow them to treat GMP benefits the same as other tranches.
This potentially gives trustees the opportunity to to wrap up all those exercises into one
“This potentially gives trustees the opportunity to to wrap up all those exercises into one,” she says, “leaving them with a simpler benefits structure to communicate to members.”
The government’s proposed method can be found here.