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UK Pensions Speedbrief – Public sector pensions: indexing and equalising GMPs – an update

  • United Kingdom
  • Pensions - Defined benefit
  • Pensions - Public sector

26-01-2018

Back in November 2016, HM Treasury consulted on proposals intended to provide equal and fully inflation-proofed guaranteed minimum pension (GMP) entitlements for male and female members of public service pension schemes.  The consultation response has now been published, and involves a further lengthy extension to the interim arrangements already in place, under which public service schemes must provide full GMP increases to members.  This development will therefore also affect those private sector schemes with rules which cross-refer to the public sector pension increase framework. 

Background

GMPs earned in contracted-out occupational pension schemes between  1978 and 1997 are subject to special rules regarding increases in payment, which are broadly intended to ensure that GMPs are fully inflation-proofed (with inflation currently being measured by reference to CPI). 

Under the GMP legislation, the occupational pension scheme is responsible for paying CPI-linked increases on GMPs accrued after 6 April 1988, up to a maximum of 3%.  Where the member has pre-1988 GMPs, or where CPI exceeds 3%, the balance of the member’s GMP increases used to be provided via an increase to the member’s additional state pension (previously SERPS).

However, under the new single-tier state pension introduced on 6 April 2016, members who reach state pension age after that date do not have any additional state pension entitlement.  As a result, the old mechanism for delivery of full inflation-proofing for GMPs no longer works for these individuals. 

Members of public service pension schemes currently benefit from transitional protection, under which members reaching state pension age up to 5 December 2018 are provided with full GMP increases (on all their GMP entitlement) from the scheme, for life.  Because of the statutory mechanism used to produce this result, some private sector schemes which incorporate references to the public sector pension increase provisions in order to state a member’s entitlement to pension increases are also currently required to provide full GMP indexation.

There is also a linked, but separate, issue regarding the equalisation of benefits to take account of the effect of GMPs.  GMPs are inherently unequal, because statute provides for them to be payable from different ages for men and women.  There is a long-running debate as to whether there is a legal obligation on schemes to adjust benefits to remove the effects of this inequality, but the Government has consistently maintained that equalisation must be achieved.

The consultation

The November 2016 consultation paper set out three possible approaches to resolving these two problems:

  1. A “case-by-case” approach. Under this option, individual calculations would be performed each year to assess whether the member’s combined state and public service pension entitlements were lower under the new system than they would have been if the old state pension regime had been retained. If they were, the scheme would be required to provide a top-up amount.
     
  2. Continuing to provide full indexation of GMPs through the public service pension scheme. This is simply an indefinite extension of the current transitional arrangements.
     
  3. Conversion of the GMP. On this approach, GMP would be converted into ordinary scheme pension on a £1 for £1 basis. The paper mentioned, but provisionally rejected, the possibility that conversion could proceed on an actuarial equivalence basis (ie. something less than a 1:1 ratio).

The Government’s response

The consultation responses received by the Government from a range of stakeholders broadly rejected the case-by-case approach as unduly complex, costly, and difficult to understand or explain to members. This option has therefore been firmly ruled out.

It appears that respondents strongly supported the third option (GMP conversion). This has the advantage that the ultimate outcome would be a simpler benefit structure, which would be easier both to administer and to understand.

However, the Government notes that conversion cannot proceed until GMP reconciliation has completed (targeted for December 2018), so that schemes are working from GMP data which is as accurate as possible.

In addition, the response states that there would be a need for a “legally and practically robust conversion methodology” (something which the DWP is already working on separately with industry representatives in respect of private sector schemes), and an appropriate legislative framework for conversion would also have to be introduced. Presumably, it is considered that the existing GMP conversion process set out in the Pension Schemes Act 1993 is unlikely to be suitable for public service pension schemes. The response also notes in passing the fact that there are ongoing (private sector) court cases on the question of GMP equalisation, and indicates that the Government would want to take account of the outcome of that litigation before finalising any conversion methodology.

For the time being, therefore, the Government is planning to kick the can down the road, with an extension of the current transitional protection for a further 2 years and 4 months (up to 5 April 2021). This will have a clear cost implication for affected schemes (both public sector and private sector) and the employers which fund them.

Comment

It was always predictable that the case-by-case approach was not going to garner much, if any, support from consultation respondents, and the Government appears to have dropped this without any real reluctance.

More interesting is the strong level of support for the option of conversion (particularly among trade unions), possibly indicating increasing levels of frustration with the practical difficulties and complexity generated by what is now a legacy system (accrual of GMPs having ended over two decades ago). However, given that conversion is proposed to be on a £1:£1 basis rather than being based on actuarial equivalence (unlike the private sector model), it is not immediately obvious why the Government considers that a “conversion methodology” is required.

Also interesting is the clear indication that the Government is intending to take advantage of the current private sector litigation as a “test case” for its position on GMP equalisation. Since the consultation paper and the response both maintain the position that the Government is required to provide full indexation of GMPs quite independently of the equalisation arguments, and that full indexation will also ensure equal treatment, it is again not particularly obvious why the Government feels the need to await the outcome of that litigation before proceeding.

For more detailed information on any of the points covered in this speedbrief, please speak to your usual Eversheds Sutherland adviser or contact:

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