The problem that is Guaranteed Minimum Pensions
15 April 2019
Equalisation of benefits for Guaranteed Minimum Pensions is causing problems for pension schemes in terms of benefits and transfer values and requires clarification from DWP, says Fiona Tait, technical director, Intelligent Pensions
Guaranteed Minimum Pension (GMP) has been in the ‘too difficult’ box for so long that for many of those reading this article it is merely a historical issue which is only relevant to actuaries and pensions geeks. Yet recently it has raised its head again and may have a significant impact on both the solvency of schemes and ability of their members to access their pensions benefits. So, what is the problem, and why has it taken so long to resolve? GMP was after all, abolished in 1997.
It’s complicated.GMPs came about when final salary schemes were permitted to contract out of the State Earnings Related Pension Scheme (SERPS), so long as they provided a guaranteed minimum pension income which was equal in value to the state benefits being given up. As SERPS was still based on unequal pension ages, so was GMP.
Following the decision in Barber v GREon 17 May 1990 pension schemes were forced to equalise their normal retirement age for men and women, action was not taken to equalise State Pension Ages until much later.
This left the conundrum of whether GMP should be equalised as part of overall scheme benefits, or left to mirror the SPA as originally intended, a situation that continued until GMP was abolished in 1997.
It’s only just been resolved.Given the difficulty of the calculations involved, and no doubt the significant pressures on the solvency of final salary schemes, a definitive decision on GMP equalisation was not made until the end of last year when a judge laid down a ruling in Lloyds Banking Group Pensions Trustees Ltd v Lloyds Bank plc and others.
In this landmark case Mr Justice Morgan stated that trustees wereobliged to equalise benefits for men and women in relation to GMP, however they would be allowed a choice between actuarial methods of doing so.
Why does it matter?
The problem is that the retirement age does not just affect the date at which benefits may be paid; it also affects the rate at which benefits are accrued and how they are revalued both before and after payment. Women generally accrued GMP more quickly than men (as the benefit was paid earlier) and it would therefore form a higher proportion of their overall pension. This is advantageous if the GMP is revalued at a higher rate than main scheme benefits, and a disadvantage if the scheme benefits increased faster in payment, as was often the case.
It follows therefore that women usually – but certainly not always – got a worse deal over the years.
What needs to be done
Trustees now need to decide on the method which they will use to carry out equalisation of GMP benefits accrued between 17 May 1990 and 5 April 1997. In very simple terms the choice is between an ongoing yearly comparison of benefits between the benefits due to male and female members so that the higher level is paid, and a one-off valuation and conversion to main scheme (non-GMP) benefits. The former provides the potential for more precise equivalence of benefits, however, it requires ongoing calculations which some trustees may wish to avoid.
Further guidance is expected from the Department for Work and Pensions (DWP), however, trustees are expected to consider their options immediately without waiting for this to come out. As well as choosing their method of equivalence they will also have to decide how to value GMP within transfer values.
What’s still outstanding?
The Lloyd’s judgment was made in relation to ongoing scheme benefits which means that it may not apply to benefits which have already been transferred. Due to this uncertainty some schemes have taken the decision not to provide transfer values until it is clarified. While understandable, it may mean that some members will be unable to access their benefits in the form of a transfer of cash or income.
The good news is that some schemes have started to include equalised benefits immediately, on the principles that 1. It is fairer for members. and 2. It is easier to carry out the exercise for single transfers than the scheme as a whole. This approach also makes it unlikely that they will face future claims after a transfer has taken place.
Those schemes who have not yet taken this decision could choose to pay the transfer without equalising, in the hope that a further ruling will exclude transferred benefits. Others may continue to hold off providing transfer values and it is difficult to predict how long this situation will last. Although there is no current timescale for when benefits must be equalised for the scheme, trustees have a statutory obligation to provide a valuation at least once every 12 months.
What difference will it make
The big question is how much of a difference it will make to people’s benefits and the answer is “it depends”. According to actuarial estimates, the majority of those affected would probably only be in line for a modest uplift of between 1-3%, however some individuals could receive compensation of over 20% of the total GMP value.
At the top of this list are those clients for whom GMP forms a relatively large part of their transfer value, who are likely to be lower paid individuals. Also on the list are members of schemes where revaluation or escalation in payment is significantly higher for main scheme benefits than the statutory rates applicable to GMP.
Each client must therefore be considered individually and a decision taken whether to proceed or wait for further clarification (click table to enlarge):
Readers of Professional Paraplanner will no doubt recall my article on this subject. It contained our top 12 pet...
The assumptions advice firms make when using cashflow models, particularly in planning DB transfers, are widely variable, warns ATEB Consulting’s...
What does the CII expect and what will give you the best chance of gaining marks? This article from Brand...