Government consultation on GMP equalisation
Royal London Consulting Actuaries
7 March 2012
It's important that trustees and scheme sponsors consider how to respond to this consultation as it could have major effects on many defined benefit schemes.
The equalisation of Guaranteed Minimum Pensions (GMPs) is not a subject that grabs much attention. However the consultation that was issued by the Government on 20 January 2012 could have major effects on many defined benefit schemes including:
- increased costs for schemes and sponsoring employers
- preventing schemes from purchasing annuities at retirement
- preventing schemes from de-risking/winding up.
It is very important that trustees and scheme sponsors consider how to respond to this consultation.
GMPs were accrued in some contracted out pension schemes between 1978 and 1997. GMPs were designed to reflect state pension provision including:
- GMP payment age is 65 for males and 60 for females
- GMP entitlement accrues at a higher rate for females than for males
- On early withdrawal GMPs must be revalued at statutory rates. For many schemes this is at fixed rates varying from 8.5% to 4.0% each year. depending on when a member stopped being contracted out. This revaluation element must be provided at GMP payment age.
- Post 1988 GMPs must increase in payment by, at least, CPI up to a maximum of 3% each year.
- If GMPs are deferred after GMP payment age they must be increased by 7% to 10% each year.
The GMP is not a separate benefit but sits within the scheme benefit. The decisions by the European Court of Justice on Sex Equalisation (Barber, Coloroll, etc) from 17th May 1990 required schemes to provide benefits on a sex neutral basis, but did not apply to state benefits.
GMPs were left in a legal limbo which neither the Government nor the courts have been prepared to resolve.
- Schemes must equalise their benefits including GMPs.
- GMP equalisation must take place irrespective of whether there is a comparator of the opposite sex.
- A sex equalisation comparison must be considered every time a pension payment is made.
(The consultation document is 12 pages long, however there is a 38 page appendix document which explains the Governments proposed method).
The method of equalisation proposed by the Government requires schemes to calculate the total amount of pension payable to a male member and to a female member at each payment. The scheme then pays the greater amount as the pension to the member.
Due to the different commencement dates of male and female GMPs, the fact that the GMP earned differs depending on sex, and the different requirements for revaluation and late payment, the advantaged sex changes over time.
The 8 examples shown in the consultation, which are based on historical outcomes from 1997, illustrate:
- Changes from female to male amounts at various ages e.g. 65, 72, or never, depending on the rates of inflation involved, the scheme retirement age and whether the member withdrew from the scheme before retirement,
- Payments of GMP between 60 and 65 to male members where the scheme benefit is not actually in payment until 65, and
- Pension increases of between 1% and 8% at the change over point.
- The Government's approach increases the benefits for members, thereby increasing the cost of providing the benefit. This increased cost will have to be funded by scheme sponsors.
- The complexity of carrying out calculations each time a monthly pension is paid will increase the costs of paying pensions. These increased costs will have to be funded by scheme sponsors.
- The annuity market depends upon insurance companies being able to forecast future pension payments. The possibility that the amount of pension will change by an unknown amount at an unknown date may mean that insurance companies stop providing annuities where there is a GMP. At the very least insurance companies are likely to increase their prices for this type of annuity.
- De-risking strategies depend upon the bulk buy-in of annuities. If annuities are not available schemes may be unable to de-risk in this way.
- Small schemes rely on the purchase of annuities to control mortality risk. If annuities are not available small schemes may have to start paying pensions from the fund each month. There may be issues with some scheme rules for such a process.
- The wind up of a scheme involves the purchase of annuities for the pensioners. If annuities are not available schemes will be unable to wind up.
The Government accepts that its approach is not the only solution to the problem of sex equalisation of GMPs. However by stating a preferred approach that approach is highly likely to become the de-facto approach that all schemes are obliged to follow.
There are three potential approaches to resolving the problem of sex equalisation of GMPs.
- To compare the male and female pensions every time a payment is made - the current proposal
- To compare the male and female pensions at one point and to then ignore the complications caused by GMP rules - the approach followed by the PPF and the FAS
- To treat contracted out benefits as just part of the scheme benefits, i.e. subject to exactly the same rules and conditions as other scheme benefits - the approach the Government introduced for post 1997 contracted out benefits.
This consultation chooses approach (a), the most expensive and complicated approach to impose on pension schemes. There is no impact assessment within the consultation to illustrate the costs this will impose on scheme sponsors, nor the consequences for the annuity market that may follow.
The consultation ignores the opportunity for the Government to simplify pension administration by implementing option (c). Nor does it allow schemes to follow the approach already followed by the PPF and the FAS.
The Government particularly wants to understand the views of trustees and scheme sponsors about its consultation. If you are concerned about the consequences, or wish to suggest that a different approach be followed, you can respond to the consultation at Equality.Regulations@dwp.gsi.gov.uk
The consultation has now closed. For more information, contact us.