Articles - Making sense of GMP conversion

The Lloyds judgment of 26 October 2018 has put Guaranteed Minimum Pension (GMP) conversion under a spotlight. The option to convert GMPs into ordinary pension scheme benefits was first introduced in 2009 but has to date only been used for a handful of schemes. This judgment considered the validity of several methods for adjusting members’ benefits in order to remove the effect of gender inequalities in GMPs and confirmed that GMP conversion was an acceptable method of equalisation.

 By Jane Beverley, Principal and Head of Research, XPS Pensions Group
 In a short supplementary judgment given on 6 December 2018, the judge determined that it was not necessary for the actuary to calculate the actuarial value of a member’s equalised pension before carrying out the conversion. Instead, it was acceptable for the purposes of conversion for the actuary to determine the higher of the actuarial equivalents of the unequalised female and the unequalised male pensions and use this as the basis for conversion. With this confirmed, the expectation is that we will see many trustees considering a one-off conversion exercise as the appropriate route for their scheme.

 The legislative requirements for GMP conversion
 1. The post-conversion benefits must be actuarially at least equivalent to the pre-conversion benefits
 2. Pensions in payment cannot be reduced
 3. The post-conversion benefits must not include any new money purchase benefits
 4. Survivors’ benefits must be at least 50% of the members’ benefits
 5. Certain procedural requirements must be complied with:

 The employer must consent in advance
 The member must be consulted before the conversion; whilst it is not clear what form the consultation will have to take, it is likely to be a challenge to provide clear communications to members on such a complex topic
 All members and survivors affected must be notified either before or as soon as possible after the conversion
 HMRC must be notified before the conversion.

 These requirements raise a number of questions, which it is hoped will be addressed in forthcoming guidance from the Department for Work and Pensions (DWP) and possibly also in amending legislation. In its recent consultation on defined benefit consolidation, the DWP indicated that it was confident that it would finalise its work with an industry working party on assisting GMP conversion, expected to include guidance, ‘in the near future’.

 Legislative ambiguity
 The legislation refers to pre- and post-conversion ‘benefits’ (not just ‘GMPs’), also stating that ‘the trustees may include other amendments which they think are necessary or desirable as a consequence of, or to facilitate, the GMP conversion’.

 This raises the question of whether the legislation permits non-GMP benefits to be converted as part of the GMP conversion process, and if it does whether that would be restricted to excess pension accrued between 1978 and 1997 alongside GMP or whether it could be extended to pre-1978 and post-1997 pensions as well.

 Such interpretations could be attractive in that they would allow for a much wider restructuring and simplification of scheme benefits, but it is far from clear that this is the intention of the legislation.

 It appears that a member’s whole GMP must be converted and that it is possible for GMP conversion to be carried out for some members and not for others.

 Post-conversion benefits
 There are few restrictions on the form of new benefits post-conversion. It would therefore seem possible for converted GMP to be replaced with a simple flat-rate pension. However, there may be practical reasons for deciding to mirror the shape of existing excess pensions in terms of revaluation and increases. As with any reshaping exercise, conversion will also lead to potential winners and losers, depending on:
 • How the pension increases
 • How long people live
 • Tax consequences.

 Impact on survivors’ pensions
 The judgment considered an argument that conversion was not possible for survivors’ pensions in payment (because of the use of the term ‘earner’ in the legislation) but found that the legislation did in fact enable GMP conversion in relation to survivors at the time of conversion.

 The restriction on survivors’ pensions appears to require them to be at least 50% of the member’s benefits, not specifically of the GMP, which is unhelpful for schemes providing a lower level of survivors’ pensions. The requirement that pensions in payment cannot be reduced may also cause problems for schemes where the GMP does not increase, but where the trustees would like to replace the GMP with excess pension increasing in line with LPI.

 Actuarial equivalence
 The legislation specifies that it is for the trustees to set the assumptions for calculating actuarial equivalence, on the advice of the scheme actuary, and for the actuary then to certify actuarial equivalence. No basis is prescribed, although many trustees may decide to use the cash-equivalent transfer value (CETV) basis.

 It is advised that trustees considering the conversion route should seek legal advice on the interpretation of the current legislation. They may also prefer to wait until the DWP has published additional guidance and confirmed whether it will be amending the legislation.

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