GMP CONVERSION A turning point
Putting GMPs through a new actuarial mincing machine to resolve inequality could be the right thing to do, explains David Everett, Lane Clark & Peacock
- GMP conversion can be used to resolve the GMP inequality issue
- the government believes that the method produced by a working group of industry experts “meets the equalisation obligation derived from EU law”
- conversion could have a number of other benefits for schemes.
Guaranteed minimum pensions (GMPs) stopped accruing in occupational pension schemes nearly 20 years ago, but recently have been enjoying a bit of a comeback as a result of the ending of salary related contracting out.
However, while the focus right now is on the reconciliation of GMP records, the next big thing for this arcane state pension substitute is about to hit the streets – resolving the inequalities in wider scheme benefits that this sex discriminatory element has generated.
Do I really need to address GMP inequalities?
Many people, of course, were hoping that the GMP inequality issue had quietly gone away, perhaps to reside in some Room 101 at Caxton House. Since the government announced back in 2013 that it had set up a working group to see whether the GMP inequality issue could be addressed through GMP conversion, there had been precious little news about its progress. There was a drip feed of announcements that the issue remained under consideration and, as far as the Department for Work & Pensions (DWP) was concerned, schemes did need to address the GMP inequality issue. However, to steal a memorable catchphrase from the much loved and sadly missed Eric and Ernie, it was “Not now, Arthur!” for the GMP inequality issue. Even the Pensions Ombudsman said as much.
Now, with the publication of a consultation paper on 28 November 2016 (well, Chapter 3 and Annex D of it to be precise), the harmonica player finally has the stage. And that stage seems to be getting crowded, as HM Treasury is also getting in on the act with its separate consultation on how to address GMP inequalities within public sector schemes. But that is a separate issue and for another day.
What is GMP conversion?
GMP conversion was introduced by the Pensions Act 2007 in response to pressure to reduce the costs and complexities of defined benefit (DB) occupational pension schemes. Under it, schemes could convert some or all of their GMP liabilities into other defined benefits without member consent, so long as, overall, benefits were not reduced in value.
First proposed by Alan Pickering in 2002, it has hardly been used since becoming available in 2009. This is mainly because it is not clear whether the GMP inequality issue needs to be addressed as part of it; and, if so, how to do this robustly in a manner in which it would never have to be revisited. There are also a number of snagging problems with the GMP conversion legislation itself.
The consultation exposes some of the latter, but only those in which there has been some resolution between the DWP and its working group. As you might expect, there remain a number of issues that need to be tackled – some relatively minor and some of substance.
Nevertheless, the really good news to come out of the consultation is a clear statement that conversion can be used to resolve the GMP inequality issue. Moreover, the method put forward by the group is an acceptable one.
This is a significant step forward because it means that if the GMP conversion legislation can be made fit for purpose, and perhaps with some accompanying guidance to help readers understand what it is saying, it will then be possible for schemes to call on their actuary to do the sums.
But then there is tax
Yes, for most of us in this life there is always tax – and for us pensions folk, particularly since the pensions tax simplification project of over ten years ago.
Unfortunately, it seems that the Finance Act 2004 is standing there ready and willing to ensnare those who dare to change the shape and form of pension benefits – sometimes even by a little. It could be the sheer nuisance of revisiting some lifetime allowance testing, recording that a bit more of the annual allowance has been used up, and perhaps worst of all, that some pre-existing lifetime allowance protections fail.
With willing parties, all this should be resolvable. After all, if one branch of government is imploring you to do something, you do not expect another branch to trip you up.
Back to the plot
But I digress. Buried in Annex D of the consultation papers is the proposed method. It comprises ten stages at the heart of which:
- Benefits accruing between 17 May 1990 and 5 April 1997 are valued on the basis of the member’s actual sex and then on the opposite sex.
- Equalisation is achieved by taking the higher of the two values.
- Any other benefit to be converted is also valued (typically in respect of any pre-17 May 1990 period during which a GMP accrued, so that all of the GMP is converted).
- The higher of the two values, along with the value of the other benefits to be converted, is turned into a revised pension benefit.
This approach therefore delivers the more valuable benefit (actual sex or opposite sex) over each member’s expected future lifetime. By contrast, the “dual record” method proposed by the DWP in 2012 involved paying the higher of the two benefits for each instalment of pension.
Although the new method appears simple in concept, it is calculation intensive, as a simple case involving a deferred pensioner demonstrates, and there are likely to be many data issues, especially for pensioners. The processing is also likely to take considerable resources. However, once done, not only will the inequalities issue have been resolved, but schemes will also be able to forget about the complexity and restrictions generated by GMPs and anti-franking requirements.
Did you say to forget about anti-franking?
Yes, that is right. If the member no longer has a GMP, there is no longer the division of benefit into a GMP and excess. But that does not mean that the member is somehow being diddled – the actuarial equivalence at the heart of GMP conversion provides the necessary safeguard.
Entering a life without GMPs has other upsides too – for example, some restrictions on transferring benefits fall away – but the real prize is that the simpler benefit structure could be part of making the scheme “buyout ready” (ie at less cost than otherwise), or as a key component of a wider benefit simplification exercise that could reduce ongoing costs. Who knows where it could end? If the scheme consolidation idea being developed for next year’s Green Paper proves to have legs, then being without GMPs could be one of a number of steps for smaller schemes to undertake before entering the non-Pension Protection Fund consolidator.
There must be a catch?
Yes and no. There is no doubt that actuaries will need to put on their best “school of hard sums” hats and develop implementations of the working group’s method, or something similar, before the conversion work can begin in earnest. As with any sums, if you want to avoid rubbish out, the data that is presented must be clean – not least of which is that the GMPs really do need to have been reconciled with HM Revenue & Customs’ records.
The implementation is also most unlikely to be a fully automated black box. There will always be schemes with complex benefit structures and members whose records aGMPre not complete. And for some calculations there will inevitably be some informed guesses necessitated by having to reach into the past to establish the point at which the GMP inequality first manifested itself.
There is then a process that needs to be followed, both internally and insofar as members are concerned. It will all need to be carefully controlled so as to ensure that it is genuinely “once and done”, but once the finishing line is reached and the member’s benefit record adjusted, that will genuinely be it. No more GMPs!
So what happens next?
The most important thing is for interested parties to critique what is being proposed. Does it work? Is it the best way of approaching the issue? Are there any workarounds that need to be explored? And then tell the DWP.
It is likely to be a little while before the fully worked up solution is on the table and the legislation is in place, but hopefully 28 November 2016 marks a turning point in the GMP inequalities saga.