Why is this important for scheme sponsors?
In light of the Lloyds judgment, many schemes are now coming to terms with what GMP equalisation will mean in practice for them. Neil Tooth and Edd Collins explain why scheme sponsors will want to take an active role in these discussions and, in light of the recent DWP guidance, consider the opportunities that GMP conversion may bring.
The Lloyds judgment on 26 October 2018 finally provided confirmation, after 28 years of uncertainty, that GMP equalisation is required. While at first glance, GMP equalisation may appear to fundamentally be a Trustee issue, there are many reasons why scheme sponsors may want a seat at the table. With a range of different methods available to implement GMP equalisation, each with a different liability impact, we expect plan sponsors will want to have significant input into the chosen method.
In addition, GMP equalisation is a complex issue for members to understand and an issue which is likely to get a lot of press attention. As such, there is a real risk to scheme sponsors of negative publicity or future legal comeback from members if GMP equalisation is not carried out properly and communicated well.
There is a real risk to scheme sponsors of negative publicity or future legal comeback from members if GMP equalisation is not carried out properly and communicated well.
Finally, GMP conversion offers plan sponsors a range of opportunities from benefit simplification to liability and risk reduction. The process requires employer consent and so we expect sponsors to use this to seek a role in shaping what conversion looks like. We believe most schemes will explore GMP conversion – a recent Willis Towers Watson poll (May 2019) of around 150 clients showed that 76% currently think they will convert GMPs.
For many of our clients, we are seeing plan sponsors seeking to input their views on GMP equalisation and conversion either by forming a joint GMP working party with their trustee to actively work through the issues, or by proactively taking the lead and putting a proposal to the trustees.
On 18 April 2019, the Department of Work and Pensions (DWP) issued further guidance on GMP conversion as an implementation route for GMP equalisation. Within this guidance, the DWP provided examples to show how GMP conversion could work in practice. In particular, the DWP set out a 10 stage process of the steps that needs to be completed by schemes who want to convert GMPs.
GMP conversion is not a new idea – the legislation has been around since 2009. Its primary purpose originally was to simplify member benefits but, due to the uncertainty around GMP equalisation, it has only been used by a small handful of schemes to date.
GMP conversion will allow schemes to implement a more streamlined benefit structure which is easier to administer. The alternative approach following the Lloyds judgment will require administrators to perform calculations on a year by year basis for members on both their own gender and the opposite gender basis (sometimes referred to as “dual record keeping”), considerably increasing the number of calculations they perform.
Therefore, GMP conversion is likely to result in lower annual ongoing administration costs than dual record keeping, as well as reducing the complexity and risk associated with future administration.
GMP conversion is likely to result in lower annual ongoing administration costs… and… completely removes GMP from the scheme
GMP conversion also completely removes GMP from the scheme. This removes the restrictions GMPs can place on the flexibility available to members. For example, for some members GMPs restrict their ability to retire early (as their GMP needs to be covered at age 60 or 65), restrict the amount of tax free cash that members are able to take (as you can’t commute GMP) and can prevent members from trivially commuting their benefits until they reach age 60 or 65. Removing statutory GMPs from the equation will therefore allow members greater flexibility to take their benefits when they want. However, it could also allow scheme sponsors to offer exercises such as trivial commutation lump sums, extinguishing liabilities for a larger number of members with small pension benefits in the scheme.
GMP equalisation and conversion will require communication to members on benefit changes and the DWP conversion guidance notes that if benefits will be materially different, trustees may wish to consider giving members options. Therefore, the conversion process may provide a good opportunity to include liability management options such as a pension increase exchange at the same time to further streamline member benefits. This would provide members with choices on their equalised pension benefits. Depending on the terms offered, these options could offset some of the additional liability resulting from GMP equalisation.
GMP conversion therefore provides a one-off opportunity to simplify benefits in a way that gives members greater flexibility and makes schemes cheaper and easier to run. However, with a range of different benefit options on the table, trustees may be naturally inclined to adopt a more cautious approach than scheme sponsors. It is therefore important for scheme sponsors to take the lead and get involved in discussions early in the process if they want to shape the outcome.
