Addressing Inequalities Arising From Guaranteed Minimum Pensions

20 January 2017

  • Following the introduction of the new State pension from 6 April 2016, all contracting-out of the State pension scheme was abolished.
  • The DWP are now consulting on draft regulations to enable trustees to administer formerly contracted-out schemes effectively.
  • Views are also sought on a new methodology for addressing inequalities in Guaranteed Minimum Pensions (GMPs). If implemented, schemes will be able to convert their GMPs into ordinary scheme benefits and, as a result, simplify administration and reduce costs.

Background

Before 6 April 2016, pension schemes were able to ‘contract-out’ of the additional State pension (SERPS/S2P). Employers and employees paid a reduced rate of National Insurance contributions and, in return, employees had to forgo some entitlement to SERPS/S2P, with their pension scheme providing a minimum level of benefits to replace this. Following the introduction of the new State pension, contracting-out is no longer possible.

Schemes that were contracted-out between 1978 and 1997 must provide GMPs for members who were in pensionable service between those dates. The amount of the GMP is intended to broadly replicate the additional State pension that the member would otherwise have received.

GMPs ceased to accrue in 1997 (when the Reference Scheme Test for contracting-out was introduced). However, members of contracted-out schemes retain the right to any GMPs they earned between 1978 and 1997. GMPs will therefore affect pension payments long into the future. They are also complex to administer. They have to be calculated and recorded separately from the main scheme benefits. They accrue at different rates for men and women, and are payable at different ages (65 for men and 60 for women). They also revalue at different rates depending on the method chosen by the scheme and the member’s date of leaving.

DWP Consultation

The Government has published a consultation on various contracting-out issues which, if implemented, will largely come into force from April 2017. In particular:

  • The circumstances in which Contributions Equivalent Premiums (CEPs) can be paid are extended (CEPs were previously payable in respect of members with less than two years’ service and effectively meant these members would be treated as if they had never been contracted-out)
  • Protections in respect of accrued benefits, where rule changes are made to formerly contracted-out schemes, are strengthened.
  • There is clarification of the circumstances in which an ‘inheritable GMP’ must be paid to a surviving spouse or civil partner.
  • Fixed rate revaluation of GMP, for members leaving pensionable service between 6 April 2017 and 5 April 2022, will be 4% p.a.

The consultation also includes a revised methodology for equalising pensions payable to men and women which include GMPs. A previous methodology was consulted on in 2012, but was dropped following widespread criticism that it would be onerous to implement and would result in both men and women receiving equalised pensions higher than either would have otherwise received.

The new methodology proposed by the DWP involves a one-off calculation and actuarial comparison of the benefits a man and a woman would receive, with the greater of the two converted into an ordinary scheme benefit under existing legislation. The existing legislation is, however, modified in order to make it easier to use. In particular, the requirement for prior member consultation is removed.

The proposed methodology is described in greater detail in a paper which has been drafted by a working group: (https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/564536/ten-stage-possible-process-for-resolving-the-gmp-inequalities-issue-for-comment.pdf).

The paper describes some of the practical difficulties that schemes may face when using this methodology and how these might be addressed. There are a number of issues which the group is still considering, such as tax issues.

The DWP’s proposal, even if implemented, is non-binding and schemes are free to use a different approach for addressing GMP inequalities. However, DWP states clearly that, notwithstanding ‘Brexit’, the Government’s position is that “the UK remains a full member of the European Union and all the rights and obligations of EU membership remain in force”.

Finally, DWP looked at other issues that have been raised in connection with the abolition of contracting-out. They were, however, unable to tackle all the points raised. For example, the issue of bulk transfers without member consent to schemes that have never been contracted-out is being worked on, but any changes to legislation will not be introduced before autumn 2017.

Comment

The DWP’s proposed “one-off calculation” approach to GMP equalisation is far more sensible than the 2012 methodology, which would have required a comparison of men and women to be undertaken each time the amount of pension in payment was calculated (at least, annually).

We suggest adding GMP conversion to the agenda for the next trustee/employer meeting, to which your scheme actuary and consultant should be invited. This will facilitate an in depth discussion of the option.

As part of a GMP conversion process, it would be possible to simplify non GMP benefits too (e.g. many schemes have complex ‘legacy’ benefit structures from historic mergers and restructures). JLT has been working with a leading pension law firm on a complete GMP (and wider benefit) conversion solution.