GMP equalisation: Time to take stock?
In this issue of XPS Pensions News, we take a step back from the Lloyds judgment and take a longer-term view of GMP equalisation.
It has been a busy few weeks for trustees, sponsors and advisers since the handing down on 26 October of the Lloyds judgment, which confirmed that pensions need to be adjusted to compensate for inequalities in Guaranteed Minimum Pensions (GMPs). To date, attention has largely been focused on short-term actions, but the festive season may prove the ideal opportunity to take a deep breath and start planning for the longer term.
First steps on the road
Our Briefing Note 13/18, ‘GMP equalisation: light at the end of the tunnel?’, provided an overview of the Lloyds judgment, including the requirement to equalise GMPs, the various methods proposed for doing so and the likely implications for trustees and sponsors.
For trustees, the immediate area of action has been to take decisions on the approach for member transactions currently in progress (or expected to take place in the next few months), whether retirements, deaths, transfers, trivial commutations or other settlements, and the revised communications to accompany these transactions. Trustees with triennial valuations or buy-out negotiations in progress may also have been taking advice on how these scheme events will be affected by the ruling.
For sponsors, especially those with 31 December accounting year-ends, the focus has been on how to incorporate an allowance for GMP equalisation into the pension disclosures in their company accounts. For more details, please see the November issue of XPS Express for Employers.
Meanwhile, we are awaiting news of whether any of the parties in the case will seek permission to appeal, the deadline for which is 24 December 2018. We are also hoping that HM Revenue and Customs (HMRC) will provide some clarity on how GMP equalisation uplifts will be treated for the purposes of the tax legislation.
Time for a pit stop?
Once trustees and sponsors have dealt with these immediate actions, the next step will be to start to put an overall project plan in place to map out the journey to GMP equalisation. In some cases, especially for larger or more complex schemes, it may make sense to put together a working party, comprising trustees, employers, administrators, actuaries and lawyers to ensure that decisions are taken in a co-ordinated fashion and then documented appropriately. It may also be helpful for the trustees and employer to have training on the judgment and the key actions required.
One of the main areas that needs to be understood is where the scheme currently stands in the process of GMP reconciliation and rectification. Most schemes have made significant progress with the process of reconciling GMP data with HMRC as a result of the end of contracting out in 2016 but, in general, schemes have not yet completed the process of rectifying GMPs to correct for the discrepancies identified during reconciliation. Trustees will now need to decide on the appropriate approach to take where benefits have to be both rectified and equalised: it is likely to be much easier to explain to members if the two processes are implemented at the same time rather than if members receive one letter explaining that their benefits are being corrected, and another, a few months later, saying that their benefits are being adjusted again, this time as a result of equalisation.
Deciding on the route
Trustees should also start to take advice on the approach that they will use to prepare for equalisation. A number of approaches were considered by the court. Methods A-C (described in our previous Briefing Note) operate by looking at the male and female pensions on a year-by-year basis and will therefore be complex to administer; method D operates by putting an actuarial value on benefits. Whilst method D should be easier to implement, the judge ruled that this could only be used as part of a GMP conversion exercise, under which GMPs are transformed into an actuarially equivalent, but simpler pension.
A recent supplementary judgment has clarified that conversion can be carried out by looking at the higher of the male and female actuarial equivalents without having to calculate the equalised benefit for each member first and then take the actuarial equivalent of that equalised benefit, which should make the conversion process easier.
The GMP conversion legislation has been in place since 2009, but has to date only been rarely used. This is partly because, prior to the judgment, there was little incentive to convert GMPs – administration systems were already configured for the complexities of GMPs as they then stood so that the cost-saving from converting GMPs was not necessarily very significant.
In addition, the GMP conversion legislation was widely felt to be poorly drafted, with a number of uncertainties of interpretation. The judge has now ruled that at least one of these difficulties (whether the definition of ‘earner’ allows the conversion of survivors’ benefits) can be resolved without amending the legislation, but the legislation remains unhelpful in a number of respects. For example, it appears to require the pension post-conversion to include a spouse’s pension of 50% of the full pension rather than just of the GMP.
Ahead of the judgment, the Department for Work and Pensions (DWP) had confirmed that it was considering some minor changes to the conversion legislation and we are also expecting some guidance from the DWP on how conversion should be implemented. We do not yet know how detailed this guidance will be, nor how much it will narrow down the range of possible ways in which conversion could be implemented: however, it seems likely that, even where trustees and employers have agreed to pursue a conversion route, they will need to decide when conversion should be implemented and what form the converted pension should take.
Given that we are still waiting for guidance (and possibly legislation), trustees and employers are unlikely to be taking definite decisions at this stage as to whether or not conversion is the right approach for them. In principle, it could offer the attraction of having simplified benefits to administer in the long term (and could, for example, make the scheme more attractive to potential consolidators or buy-out providers). Employers may well be keen to carry out GMP conversion exercises alongside pension increase exchanges as a way to make overall cost savings. However, it is worth noting that, as GMP conversion is intended to achieve actuarial equivalence for an average member, some members will benefit from conversion and others lose out, depending on individual experience.
Trustees and employers should also be seeking to understand from their administrators the likely costs of operating the year-by-year methods so that they can understand the advantages and disadvantages of both routes.
Even though the Lloyds judgment was 174 pages long, it failed to answer certain key questions. In particular, the subject of transfers out was deferred to a (possible) later hearing. This means that, even when schemes have taken their final decisions on the methodology to adopt for current scheme members, it is possible that they may need to carry out a separate exercise in respect of some or all of their former members.
The road to GMP equalisation remains a long and complex one for trustees and employers, but the way can be smoothed with careful advice and decision-making, strategic planning and good communication between trustees, employers and advisers.