Solution to guaranteed minimum pensions problem may be on horizon, says expert

Out-Law Analysis | 13 Dec 2016 | 10:16 am | 3 min. read

FOCUS: It has taken a long time to get there, but at last it looks like a potential solution to the problem of equalising guaranteed minimum pensions (GMPs) could be in the offing.

The UK government is consulting on a new draft method for equalising GMPs, which involves doing so before converting them into ordinary scheme benefits. Unlike the government's previous proposal, which the pensions industry roundly derided, this method has been developed by an industry working group and should finally allow scheme trustees to equalise with confidence.

Implementing GMP equalisation on the basis of the proposed new method won't necessarily be plain sailing and, with Brexit looming, is not something that trustees should be rushing to do immediately. However, almost six years after the Department for Work and Pensions (DWP) confirmed that it would legislate for equalisation, the prospect of an official solution should be welcomed by trustees and scheme managers.

The problem

GMPs are final salary benefits provided to pension scheme members in return for contracting out of the State Earnings-Related Pension Scheme (SERPS) at any point between 6 April 1978 and 5 April 1997. In 1990, the Court of Justice of the European Union (CJEU) ruled that pension benefits must be equal for men and women in respect of service from 17 May 1990. However, this did not extend to state benefits and UK legislation governing GMPs continues to provide for a pension age of 60 for women and 65 for men.

Pensions lawyers have long argued about whether GMPs, despite being a substitute for a state benefit, should be equalised under EU law. Although there are arguments to the contrary, the general view is that GMPs must be equalised, and the government agrees. But, to date, nobody has managed to agree on how to do it.

The proposal

The new method, set out in the government's consultation, involves a one-off calculation to equalise GMPs before converting them into ordinary scheme benefits.

The law allowing conversion has been in place since April 2009, but conversion does not of itself solve the problem of equalisation. In January 2012, the government came up with an equalisation method which involved annual benefit adjustments for each member. The pensions industry roundly derided this method, which also resulted in overcompensation.

The new method, proposed by the DWP's industry working group after years of study, is decidedly more practical. Members' benefits will need to be adjusted only once before conversion, assuming they are calculated as worth less than the equivalent benefits for the opposite sex. Not only will trustees have then equalised the benefits once and for all, but they will no longer need to worry about all of the administrative peculiarities relating to GMPs - including tricky things like anti-franking.

Once in place, trustees should be able to use the new method to at last equalise with confidence. Whatever the remaining legal and actuarial uncertainties about equalisation may be, a court is unlikely to rule against trustees who apply a method which a DWP-sponsored working group has developed over a number of years, and on which the government has consulted. The government has already stated that it believes the new equalisation method "meets the equalisation obligation derived from EU law".

The DWP has also stressed that this is simply one way of equalising GMPs. Many schemes that have wound up have already had to come up with their own solutions to address the problem. The method they chose is not necessarily wrong just because it differs from the one now being proposed.

The complexities

However, although the proposed method involves only a one-off calculation for each member, that calculation is not straightforward and will not necessarily be a simple solution to implement. It requires accurate membership data, including historical data about the level of the main scheme benefits as well as GMPs during the relevant period. Once the calculation has been carried out, administration systems will need to be updated to ensure the correct, adjusted benefits are paid.

Trustees will need to consider with their legal advisers what to do about payments already made to members on an unequalised basis, including death benefits and transfer payments. They will also need to establish the tax treatment of payment adjustments. Trustees will need to factor in administration and legal costs, alongside the actual cost of compensation.

Most trustees have delayed acting on GMP equalisation up until now because it was unclear what they should do. However, once the consultation is over and the new method and revised legislation finalised, it will become more difficult to justify further delay.

One reason for holding off might be the hope that, following Brexit, the government will introduce a law reversing the requirement to equalise GMPs. However, although this is possible, it is unlikely to be at the top of the government's agenda. Trustees may also wish to wait for the outcome of a trade union's case that GMPs in the Lloyds Banking Group pension schemes should have been equalised, which is due to be heard by an employment tribunal.

However, many schemes will not have the option of delay. For example, schemes wishing to secure their liabilities by buying annuity policies will be confronted straight away with the issue of what to do with their unequal GMPs.

Simon Tyler is a pensions expert at Pinsent Masons, the law firm behind Out-Law.com.