Guest comment: Unequal ways of equalising pension benefits

As many readers of Pensions Age know, the courts did not address the inequality in guaranteed minimum pensions (GMPs) between men and women until 2018. UK occupational pension schemes are now obliged to equalise benefits between men and women to compensate for the inequality in GMP, which is known as GMP equalisation.

However, more than three years down the line, many ongoing pension schemes have not yet complied with this requirement. This article will explore the various legally permitted ways of satisfying the obligation to equalise for GMPs, which involve varying degrees of cost and difficulty, depending on the characteristics of the pension scheme membership.

GMP equalisation is an important issue for both pension trustees, who have to implement it, and for sponsoring employers, who may ultimately have to bear the cost, through their balance of cost employer contribution obligation to the pension scheme.

In terms of solutions, so called method B, which requires a year by year comparison of the total benefit paid to a male and a female member with the same service and pay, is emerging as the most straightforward option, but this method may involve a higher cost than other methods in terms of the benefits provided. A hypothetical comparator of the opposite sex is used to compare the benefits paid to a male and a female member for this purpose.

The two main alternative methods, by way of contrast, may involve a lower benefit cost, but higher administrative or advisory cost. So-called method C2 is the legal default method because it is the only method which the pension trustees could implement without requiring the formal legal agreement of the sponsoring employers. Best practice, however, would be to consult with the employers in any event, in view of the significance of the exercise. Method C2 requires a cumulative comparison of the total benefits paid to a male and a female member with the same service and pay. This requires that pension schemes retain dual records for each affected scheme member, both of their own benefit entitlements for service from 1990 to 1997 and of the corresponding benefit entitlements for such service of a hypothetical comparator of the opposite sex.

Female members will generally have the greater GMP benefits, because they are entitled to a higher GMP accrual rate and are entitled to be paid their GMP at a lower age than men. Male members will generally therefore have the corresponding right to claim a GMP equalisation payment, but there may be some years where the male member receives the greater GMP benefit, and accordingly where the female member has the right to claim a GMP equalisation payment.

Method C2 provides for there to be an offset of the years where male or female members, as the case may be, are entitled to the higher GMP. This means that only the minimum additional GMP equalisation payment is made under C2. Method C2 also provides for interest to be applied to allow for the period of delay in making up arrears of benefit by way of GMP equalisation payments. There is no such offset under method B.

However, method C2 is therefore more complex than method B and is likely to have a higher administrative cost. The higher administrative cost could in some cases outweigh the higher benefit cost of method B. Method B may also have the attraction of being simpler to communicate to scheme members.

Method C2 comes with the additional potential disadvantage of requiring a reduction in future payments of pension to some existing pensioners, alongside a payment of arrears of benefit which may be made as an immediate lump sum.

The third and last main method of GMP equalisation is so-called method D2. This involves GMP conversion, converting GMP into non-GMP. This has the benefit of removing GMPs altogether, with the attendant complexity that surrounds GMPs. Method D2 only applies to future payments and not to payments of arrears of benefits, which must involve method B or method C2.

GMP conversion requires that each scheme member or spouse is provided with converted benefits of at least equal value overall to the GMP benefit which is being removed. GMP conversion therefore requires alternative pension benefits to be designed for scheme members.

Those alternative scheme benefits may be made as close as possible in amount to GMPs, which would save cost on the design of the benefit, whilst retaining some of the complexity of GMPs, or may be made radically different from GMPs. This could simplify scheme benefits but also involve higher benefit consultancy costs and a greater potential risk of additional pensions tax liability on any increased benefits provided for higher earners and for those with longer service. Such tax liability would arise by causing the Annual Allowance and Lifetime Allowance applicable to benefits under registered pension schemes to be exceeded and, most seriously, by causing certain protections against the Standard Lifetime Allowance to be lost.

GMP conversion, or method D2, will in any event involve potentially significant additional actuarial fees at the outset in ensuring that the converted benefits for each member or spouse are at least equal in value to the removed GMP.

GMP conversion would, on the other hand, dispense with the additional administrative costs of calculating and implementing GMP equalisation benefit increases in future. This cost saving may or may not be outweighed by the additional actuarial fees involved in method D2. Cash constraints may mean that pension trustees and sponsoring employers are unwilling to bear an immediate cost in actuarial fees in return for a future saving in scheme administration costs, even if this would seem likely to result in a cost saving in the long term.

Pension trustees and sponsoring employers of formerly contracted-out defined benefit pension schemes need carefully to consider which legally permitted method of GMP equalisation to choose. That choice may be made on the basis of which method would give rise to the lowest overall cost, taking account of both benefit costs and additional administrative and adviser costs, and which method would provide the most suitable outcome for scheme beneficiaries. The choice of GMP equalisation method is also not necessarily a 'one size fits all' question. Different methods of GMP equalisation may be appropriate and applied for different groups of pension scheme members.

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