1. What is a contracted out pension scheme?
2. Why did schemes choose to contract out?
3. What is GMP?
4. How might GMP benefits differ from other scheme benefits?
5. How is GMP calculated?
6. What is the difference between the levels of male and female GMP?
7. How does GMP create inequality in members’ benefits?
8. How might this affect my state benefits?
9. Didn’t most schemes equalise benefits in the mid-1990s?
10. What was the Lloyds case about?
11. What are the principles behind GMP equalisation?
12. Who is affected/not affected by GMP equalisation?
13. What about previously transferred benefits?
14. Could any members be worse off as a result of equalisation?
15. What are the different GMP equalisation methods and how do each of the different methods work?
16. Can the period for which back payments are due, be limited?
17. Why is GMP equalisation so complicated?
18. What is GMP conversion?
19. What does a dual record keeping approach involve?
20. What are the links with other projects around GMP?
21. How long will it take to resolve?
22. What is the likely impact of GMP equalisation on scheme funding?
23. Why is the scheme impact typically 0–3% but member impacts could be more than 10%?
Until 5 April 2016, the State pension was made up of two parts – the Basic State Pension, and an Additional State Pension based on earnings. The additional earnings-related pension was known as the State Earnings-Related Pension Scheme until 5 April 2002, and later replaced by the State Second Pension until 5 April 2016.
It was possible for defined benefit occupational pension schemes to ‘contract out’ their members from the State Earnings Related Pension Scheme (SERPS) if they provided at least a minimum level of benefit to members through a workplace pension.
Contracting out ceased from 6 April 2016 when the State pension moved to a single tier pension.
For a defined benefit occupational pension scheme, it was not possible to contract out on a member-by-member basis. Schemes either needed to have all members contracted out or have all members “contracted in” – i.e. all members received the additional state pension as well as scheme benefits.
Employers received benefits from the government if they opted to contract out workers from SERPS. Members of contracted out pension schemes, and their employers, would pay a reduced or redirected rate of National Insurance contributions in return for contracting out of the Additional State Pension.
Guaranteed Minimum Pension (GMP) is the minimum guaranteed level of pension, which a pension scheme had to provide to members if they were contracted out of the SERPS between 6 April 1978 and 5 April 1997.
If a scheme was contracted out, some or all of a member’s pension accrued between 6 April 1978 and 5 April 1997 will be made up of GMP.
GMP was designed to replicate the State benefits given up. Therefore there are different statutory rules surrounding how GMP must be treated, compared to other pension benefits provided by an occupation pension scheme. Some of these differences are set out below:
The Guaranteed Minimum Pension calculation was set to provide members with a pension that was at least as much as that which they would have earned under the SERPS, payable from their GMP payment age, i.e. 60 for females and 65 for males (in line with the State Pension Ages during that period).
The calculation of GMP takes into account relevant earnings of the individual and the period of qualifying service during which the member was contracted out.
For the purposes of calculating GMP, qualifying service is calculated based on Working Life which is given by the following formula:
Number of complete tax years since 6 April 1978 in the member’s working lifetime (which is between age 16 and 65 for men, and between 16 and 60 for women).
Broadly:
For GMP accrued prior to 6 April 1988
GMP accrued at a rate of four-times working lifetime, applied to each tax year’s relevant earnings from 6 April 1978 to 5 April 1988, revalued to date of leaving contracted out service.
For GMP accrued from 6 April 1988
GMP accrued at a rate of five-times working lifetime, applied to each tax year’s relevant earnings from 6 April 1988 to 5 April 1997, revalued to date of leaving contracted out service.
As defined above, Working Life is given by the following formula:
Number of complete tax years since 6 April 1978 in the member’s working lifetime (which is between age 16 and 65 for men, and between 16 and 60 for women).
This means that qualifying service for GMP is a maximum of 44 years for females and 49 years for males (the lower service period for females reflected the shorter working lifetime given their lower GMP payment age). A female’s GMP therefore accrued at a faster rate than that of her male counterpart, for the same period of service.
As noted previously, at date of leaving contracted out service, the member’s total benefit is unaffected by whether the member is male or female (provided that there is sufficient pension to cover the GMP). The only difference between the two genders is that female members generally have a larger proportion of their benefits as GMP.
GMP is accrued at a higher rate for females
On leaving service a female will have built up a greater amount of GMP requirement than that of her male counterpart. Therefore, for a male and female with identical period of service and pension on leaving, the proportion of pension relating to GMP is higher for a female.
GMP is payable at different retirement ages
GMP is available from 60 for a female. For a man it is only available from 65. This tends to favour females, particularly due to the large statutory late retirement uplift applied to GMP pension that is applied after GMP payment age, but depends on whether the GMP can be taken independently of other scheme benefits.
GMP revaluation in deferment
Generally a higher revaluation applies to GMP than non-GMPs. Therefore, for a male and female who have accrued the same pension from a scheme, the revaluation of a female’s deferred benefit is generally higher until age 60, reflecting the higher proportion of GMP element.
GMP increases in payment
For GMP accrued prior to 5 April 1988 there is no duty to provide inflation-linked increases in payment, however for GMP accrued from 6 April 1988, schemes must provide inflation-linked increases in line with CPI up to 3% (previously RPI prior to 2010). There is no statutory requirement to provide increases on non-GMP pension accrued prior to 6 April 1997, however some schemes chose to provide an increase on this pension based on their scheme rules. Therefore if males and females have different GMP proportions, their pension in payment will increase at a different rate. This could favour either gender (and it could change during retirement).
If you were contracted out for a period of service, your State pension payable will be adjusted.
If you retired before 6 April 2016, then you will receive your basic state pension entitlement (subject to meeting qualifying criteria). You may also be entitled to some additional earnings related pension, however for any period you were contracted out of the SERPS, the value of your GMP will be deducted from the full SERPS entitlement you would have received, had you not been contracted out.
If you retire after 6 April 2016 the single tier pension will be adjusted to reflect the period you were contracted out of the SERPS.
Following the European Court of Justice ruling on 17 May 1990 (Barber vs Guardian Royal Exchange Assurance Group), occupational pension schemes were obligated to provide equal benefits to men and woman from this date onwards.
However, it was not clear whether GMP was required to be equalised as GMP was intended to replicate State benefits, which weren’t required to be equal for men and women. As a result of the uncertainty, most schemes did not equalise for the impacts of the GMP element of pension. Instead most schemes chose to only equalise any non-GMP elements of pension.
Prior to the judgment, the law was not clear about whether GMPs should be equalised and, if so, how this might be done in practice. The recent Lloyds Banking Group case went to the High Court to decide whether GMPs need to be equalised and, if so, the calculation method to use to adjust members' benefits. While the judgment relates to the Lloyds Banking Group schemes, it is expected to provide a legal precedent that affects other schemes as well.
The judgment was announced on 26 October 2018 and confirmed that GMP equalisation is required. It provided the Trustees with a number of potential approaches for achieving this.
The judgment from the High Court is likely to affect many UK pension schemes with 'defined benefits'. Members could be affected if they are in one of these schemes and had built up a GMP between 17 May 1990 and 5 April 1997. This will include some 'defined contribution' schemes where there is an underpin benefit equal to the GMP.
A member’s statutory GMP entitlement is not affected by the Judgment on 26 October 2018, and members’ GMPs will not be equalised as a result. Instead, the result of the Judgement requires that members’ benefits must be equalised for the effects of unequal GMP.
The Court hearing is only likely to affect members, or beneficiaries of members, who built up a GMP between 17 May 1990 (the date of the Barber v GRE judgment) and 5 April 1997 (when GMPs ceased to accrue). Members who transferred in benefits from a previous scheme which include GMP built up over this same period will also be impacted. Other members are unlikely to be affected by the judgment.
The Court judgment could affect the pensions for both men and women, and both pensioners and non-pensioners.
There are still a number of unresolved matters following the judgment including the position on historic transfers out.
The value of members’ pensions will not go down as a result of GMP equalisation. Any underpayment from previous payments made will also need to be equalised, and some members may be due a back payment.
The Lloyds judgment does not necessarily mean that members’ benefits will increase. This will depend on their individual circumstances and will require detailed calculations to determine.
The impact of GMP equalisation for individual members will depend on the method of equalisation chosen by the trustees and the individual member’s circumstances.
There were various methods discussed by the High Court in order to equalise benefits.
Statutory limitation periods on back payments do not apply in relation to GMP equalisation. However, Scheme rules should be reviewed to determine if any limitation periods apply and if the Trustees have the power to limit potential back payments for members who have been previously underpaid.
It is important for Trustees to also understand the implications of limiting back payments and you should speak with your actuarial adviser and legal adviser to understand the implications further before making any decision.
There is no one single solution to GMP equalisation and there are a lot of moving parts.
Data
The data used for GMP equalisation purposes is different from the data used for day-to-day administration and therefore may not be readily available. GMP equalisation can’t be completed until a GMP rectification exercise has been finalised, so this should be a key priority for trustees. It is important to capture all the data used as part of GMP rectification, so that this can be used for GMP equalisation calculations. It would also be worth the trustee undertaking checks to ensure whether any further data is required to perform the GMP equalisation work, making sure that all the necessary preparation has been done ahead of the calculations being performed.
Method, calculations and policy decisions
Trustees of schemes will need to make policy decisions regarding the method of equalisation and how this will be implemented. There are still a number of legal uncertainties around GMP equalisation that need to be resolved before GMP equalisation can be finalised, but following the Lloyds judgment planning can start and key policy decisions can start to be made by Trustees on methodology, treatment of back payments, and dual record keeping or conversion.
Member communications
Given the complicated nature of GMP equalisation, and that this exercise will directly impact member benefits, the member communication will be crucial to the success of this project. It is important that members are given the key information that directly impacts them, delivered in a clear way that they are able to understand. It is important that trustees think about the communication aspects of GMP equalisation throughout the project to help aid decision making.
There will be many different parties involved (including members, actuaries, lawyers, trustees and administrators) in all of the key steps for GMP equalisation (planning, data, policy decisions, calculations, updating processes, and member communication as examples). Good project management will be key to a successful GMP equalisation project to help ensure the project runs smoothly.
Since 6 April 2009, Trustees have been permitted to convert members’ GMP rights into alternative scheme benefits under legislation. Following conversion, trustees are no longer required to track and monitor GMPs.
In practice, GMP conversion has rarely been implemented, largely because of uncertainty around GMP equalisation. However, to the extent that the Lloyds judgment has resolved some of the uncertainty, many schemes are likely to revisit GMP conversion as an option for implementing GMP equalisation and simplifying GMPs going forward.
The method of converting GMP benefits requires an actuarial value calculation to convert existing benefits into a new form. The current conversion legislation has not been greatly used to date and further guidance is expected from DWP about how they envisage conversion being used in practice.
Schemes may find conversion attractive as it simplifies scheme benefits and removes the restrictions around GMPs. On 3 December 2018 there was a further hearing in the High Court, which confirmed that the conversion approach to GMP equalisation is free-standing for future benefit payments. This means to convert future benefits you wouldn’t have to equalise first and you can convert and equalise at the same time.
When considering conversion as a possible option, it is important that trustees understand all of the potential benefits and costs of GMP equalisation and should take legal and actuarial advice before proceeding.
If GMP is not converted (and unless it can be shown that the member, or their comparator gender benefit, would always be better off), schemes equalising using one of other methods set out within the Lloyds judgment will need to keep a record of a member’s pension entitlement, and that of a member of the comparator gender for any benefits accrued between 17 May 1990 and 5 April 1997.
Maintaining dual records will be administratively more complex and will require system changes to implement. It is also likely to require current operational processes (such as pension increase exercises, transfer value calculations and trivial commutation calculations for example) to be updated. Dual record keeping is also likely to lead to additional complications in communicating to members about their benefits over the longer term.
For many schemes, GMP equalisation is one of several projects they are currently looking at in relation to GMP benefits.
GMP reconciliation and recalculations
Schemes will need to complete their reconciliation and recalculations projects to enable them to have correct data to carry out their equalisation calculations.
An equalisation project will also require additional data, which may not have been required as part of the recalculation project (and may not be stored as part of the ongoing administration of the scheme). This data will need to be obtained or calculated and consideration about what extra data is likely to be required should start early to make sure it is available once trustees get to the calculation stage.
Separately, once reconciled pensions (including the value of any under and over payments) have been recalculated, schemes will also want to consider whether to implement corrections immediately and communicate these changes to affected members. Alternatively, as GMP equalisation may result in a further change to members’ benefits, schemes may wish to correct benefits in a single communication exercise following GMP equalisation.
However, it should be noted that although there may be some overlap, members requiring GMP recalculation (as scheme GMP records vs HMRC records were incorrect) will not necessarily be the same population requiring equalisation of benefits. This is because GMP reconciliation affects all members with GMP between 6 April 1978 and 5 April 1997 where benefits don’t match the information held by HMRC, while GMP equalisation can only affect members who accrued GMP between 17 May 1990 and 5 April 1997. Schemes should therefore think about their own individual circumstances and receive both legal and actuarial advice to decide their best course of action. Early planning will be essential in seeing how GMP recalculation and equalisation sit alongside each other and ensuring the best experience for members.
Many schemes will only recently have finished raising queries with HMRC as part of their GMP reconciliation project. It may then take several months to rectify benefits once responses have been received. Work on GMP rectification will need to be completed before data for GMP equalisation is available.
At the current time, we would expect the main focus for trustees to be:
With legal uncertainty still remaining over a number of aspects in relation to GMP equalisation, it is important that trustees keep up to date with the latest developments in relation to GMP equalisation and make sure these are taken into account within the project plan.
The typical cost of GMP equalisation is estimated to be between 0% and 3% of liabilities, however the impact will be very specific to the benefit structure of each scheme and the membership profile.
Given that the GMP equalisation impact is highly dependent on benefit structures and is therefore very scheme specific, you will need to speak with an adviser to investigate the specific impacts for your scheme.
Scheme impact considers all members. Many members of the scheme will not be impacted, as equalisation of GMP only affects members who built up GMP between 17 May 1990 and 5 April 1997.
Even for those members who are impacted, due to having GMP accrued between 17 May 1990 and 5 April 1997, the impact on their benefits will vary depending on a number of factors including:
