Legislation allowing for Guaranteed Minimum Pension conversion has been in place for a number of years. However, the take-up has been limited. This is partly due to concerns about the legislation itself (for example, how it fits with survivor pensions) and partly as it has not been clear whether it is necessary to equalise GMPs – and, if so, how equalisation would fit with GMP conversion.
The judgments in Lloyds Banking Group Pensions Trustees Ltd v Lloyds Bank PLC and others answered the question relating to survivor pensions. They also confirmed that trustees must equalise GMPs earned between May 1990 and April 1997 and explained how equalisation can fit with conversion. As we reach the first anniversary of the main Lloyds decision, we ask if it is time for trustees and employers to start to think about GMP conversion?
What is GMP conversion?
GMPs are governed by rules set down in legislation. These rules are usually different to a pension scheme's own rules, which apply to any pension a member has in excess of the GMP.
GMP conversion involves 'converting' a member's GMP into a scheme benefit which is not subject to the GMP rules. This can make benefits easier to understand and to administer.
What requirements apply?
Trustees must comply with a series of requirements set out in the GMP conversion legislation. For example: the post-conversion benefit must be "actuarially at least equivalent" to the original benefit; the scheme must provide a minimum level of survivor benefit; the trustees will need the employer's consent to conversion; and the trustees will need to consult members.
The Department for Work and Pensions published guidance on the use of the GMP conversion legislation in April 2019. The guidance suggests a 10-stage conversion process, which is not compulsory but which will achieve GMP equalisation and compliance with the GMP conversion legislation.
The GMP Equalisation Working Group has released a call to action suggesting steps that schemes should consider taking now to prepare for their GMP equalisation project. It has also released a detailed guidance note which covers a series of points relating to GMP conversion and suggests steps that schemes can take now in relation to, for example, members who have transferred in.
These guidance notes provide a very helpful starting point. Trustees and employers will also need to take legal advice, actuarial advice and work very closely with their scheme administrators.
Do schemes have to convert everyone's GMP?
No. You can decide to convert the GMP relating to a single member or to limit the conversion exercise to a particular group of members. You can also approach conversion in stages: you will usually be able to convert the GMP for one group of members with a view to converting the GMP of another group later. However, you must convert the whole GMP for every member included in your exercise. This means that you cannot convert just GMP earned between May 1990 and April 1997 (the part the Lloyds case has confirmed must be equalised).
Which schemes is GMP conversion suitable for?
Each scheme with GMPs is different and trustees and employers will need to ask their advisers whether GMP conversion is suitable for one or more groups of member in their scheme. This discussion will usually include an analysis of whether the benefits of a GMP conversion exercise for some or all GMP members are likely to justify the upfront costs, particularly if the cost impact of GMP equalisation is expected to be modest. These costs include the need to comply with the five conditions and the consultation and notification process required by the conversion legislation in light of the recent DWP Guidance.
All schemes need to take action to equalise GMPs. The alternative to GMP conversion is to adopt one of the 'year-by-year' approaches discussed in the main Lloyds judgment. However, conversion may not be necessary to avoid ongoing complexity for pensions in payment. For example, if the scheme rules pay the same fixed pension increase on all benefits accrued from 6 April 1988 to 6 April 1997 (including the GMP) then, once the retirement pension is equalised using one of the other methods permitted in the Lloyds judgment, no future discrepancy between the male and female pension will arise.
We expect conversion to be more popular with those schemes needing to equalise and wishing to simplify benefits for GMP members and potentially save costs as part of this, whether in terms of the scheme's ongoing administration or the cost of buying-in their benefits. GMP conversion gives trustees the opportunity to equalise GMPs and replace them with a benefit which is easier to administer. In turn, the new benefit may be easier for an insurer to price and cheaper for them to administer once buy-out occurs.
There will be a balancing act: the greater the simplification, the more complex and costly the conversion process is likely to be, but the greater the future cost savings might be (assuming that administrators and insurers will in due course offer improved terms).
Schemes that convert to a single benefit structure for pre-1997 benefits may have the most to gain over the longer term, particularly those that have unusually complicated scheme rules and benefit structure. However, less drastic forms of conversion are available, such as converting the GMP to an identical benefit that is not governed by the contracting-out legislation; although care would be needed, for example, to ensure that the overall survivor benefit is equal for men and women.
Considerations for member groups
For trustees considering conversion, one or more groups of pensioners would be a good place to start, as their benefits have been calculated and few assumptions are needed to value them. Many schemes also start by insuring pensions in payment as pensioners are generally cheaper to buy-in.
Schemes that are still open to future accrual (that still have active members), or have deferred members who are still employed and entitled to a salary link are problematic. The trustees would need to choose a single conversion date. This would involve agreeing a set of assumptions to use to value each member's benefit. This, in turn, would involve making assumptions about the age members will leave service or retire, and about future salary increases and/or revaluation rates and retirement options. If the members are still some distance from retirement age, these assumptions could be difficult to agree and reconcile with the trustees' duties to such members under trust law.
Assumptions relating to, in particular, revaluation rates would also be required for deferred members without any salary link, although these are likely to be easier to agree.
Conversion prior to buy-out
If there is not time to convert before a buy-in completes, trustees could check that the terms of the buy-in policy will allow member benefits to be adjusted after purchase but before buy-out, in order to permit GMP equalisation and conversion during the winding up process. Indeed, some insurers might insist that GMP equalisation and conversion is completed before buy-out or offer preferential terms to those that do convert in order to simplify their ongoing administration.
The available options need to be investigated and discussed as part of the buy-in process. The terms of the policy would also need to be carefully considered and negotiated where appropriate.
One advantage of converting GMPs as part of the wind-up and buy-out process is that no employer consent or member consultation would be required, thereby simplifying the conversion process.
Are there any barriers?
Before embarking on GMP conversion (or equalisation), schemes need to complete their GMP reconciliation exercise in order to be sure that their record of members' GMPs is correct. Schemes also need to look at whether they have the data they will need in relation to members' GMPs and excesses.
Beyond this, the main uncertainty is tax: how will the adjustments to benefits made as the result of GMP conversion be treated for pensions tax (annual and lifetime allowance and tax protection) purposes? It is hoped that HMRC and the industry working group might issue updates this autumn that address this question.
Osborne Clarke comment
Trustees and employers devising their GMP equalisation plans during 2020 may wish to consider whether GMP conversion could be a suitable equalisation method for some or all GMP members and whether conversion could have wider benefits for their scheme. Once the tax uncertainties are more settled, we anticipate that GMP conversion will become more attractive and commonplace.
Because many equalisation uplifts are modest, a costs-versus-benefits analysis might not support converting GMPs purely to achieve GMP equalisation. However, the opportunity to simplify benefits – whether to make the scheme more attractive to an insurer or to reduce long-term administration costs – could be a strong driver.