Guaranteed minimum pensions conversions go live
In an effort to simplify administration for contracted-out defined-benefit schemes, the government has introduced legislation that allows guaranteed minimum pensions to be converted into ordinary scheme benefits. However, as with so many pension simplification measures, it is not that simple and take-up is likely to be very limited.
On this page:
Guaranteed minimum pensions - a reminder
Converting guaranteed minimum pensions
Five conversion conditions
Actuarial equivalence
Survivors' benefits
Survivors' benefits in practice
Procedural requirements
Transfers out
Powers to amend schemes
Enforcement
Effect on Serps
Likely take-up
Costs and savings of guaranteed minimum pensions conversion
Our research.
Summary of key points
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Although guaranteed minimum pensions (GMPs) stopped accruing in April 2007, they remain an important element of many scheme members' rights and are incredibly complex. Recent legislation gives trustees the opportunity to convert this legacy benefit into ordinary scheme benefits. Here we examine the new legislative provisions.
Guaranteed minimum pensions - a reminder
GMPs were introduced by the Social Security Pensions Act 1975 together with the state earnings related pension scheme (Serps) and both came into force from 6 April 1978. Employers who provided a defined-benefit occupational pension scheme that met two tests could "contract out" employees from Serps, with both employer and employees paying lower national insurance contributions. The two tests were:
- the guaranteed minimum pension test, which involved the scheme providing a pension broadly equivalent to the additional state pension entitlement being given up; and
- the requisite benefit test, which involved the provision of a pension of at least 1/80th of pensionable salary for each year of pensionable service.
The requisite benefits test was abolished in November 1986 as part of the changes made by the Social Security Act 1986. This statute also introduced a further method of contracting out of Serps by use of the protected rights test via the newly introduced contracted-out money-purchase and appropriate personal pension schemes.
Under measures contained in the Pensions Act 1995, GMPs ceased to accrue for future service from 5 April 1997. An important driver in this change was the ruling of the European Court of Justice on 17 May 1990 in the Barber case, which found that unequal normal pension ages for men and women were contrary to European law. As GMPs were directly linked to unequal state pension ages, they could not easily comply with the law.
The November 1986 change was a key moment. Had the government instead abolished the GMP test and retained the requisite benefits test, which required an equal accrual rate for men and women, compliance with the principle of equal treatment would have been easier for contracted-out salary-related (COSR) schemes to achieve.
Converting guaranteed minimum pensions
The proposal to convert GMPs was first put forward by the Department for Work and Pensions (DWP) in 2003, forming part of the consultation exercise for the Pensions Act 2004. However, the DWP did not proceed with it at that time.
The main legislation now governing the conversion of GMPs into accrued scheme benefits was added to the Pension Schemes Act 1993 by the Pensions Act 2007. A consultation exercise on draft Regulations was conducted and the definitive Regulations1 came into force on 6 April 2009, amending the Contracting-out Regulations 19962 with effect from that date.
Five conversion conditions
Five conditions have each to be met if a COSR scheme is to be exempt from the requirement to provide GMPs to those who have accrued such rights at any time during the period from 6 April 1978 to 5 April 1997. These are as follows:
- condition 1: the post-conversion benefits must be actuarially at least equivalent to the pre-conversion benefits;
- condition 2: if the earner was entitled to the payment of a pension under the scheme immediately before the conversion date, the converted scheme must not provide for a reduction of, or have the effect of reducing, the amount of that pension immediately after conversion;
- condition 3: the post-conversion benefits must not include money-purchase benefits, apart from any money-purchase benefits provided under the scheme immediately before the conversion date;
- condition 4: the converted scheme must provide survivors' benefits, as set out in the Regulations; and
- condition 5: the procedural requirements must have been complied with.
In applying these conditions to a scheme in respect of an earner, it is immaterial whether or not the scheme was also converted in respect of other earners on the conversion date. Also, except for condition 2, it is immaterial whether or not the earner was entitled to the payment of a pension under the scheme.
As noted above, a powerful driver for change is that, when considered on their own, GMPs are not sex equal. The equal treatment requirements naturally continue to apply after conversion at least to the overall scheme benefits. Actuarial consultancy Mercer comments: "Thus conversion has the effect of crystallising the equalisation cost and hastening a decision which might otherwise be 'on hold'. This could be a major stumbling block for GMP conversion."
Actuarial equivalence
The Contracting-out Regulations 1996 set out how the actuarial equivalence requirement for the pre- and post-conversion benefits must be met. It is the responsibility of the scheme's trustees to determine that the required actuarial equivalence condition is met, but, of course, in so doing they must obtain advice from their actuary on what assumptions are appropriate at the conversion date, consider that advice, decide what assumptions are to be used (and, if the trustees later think it is necessary, change that decision) and arrange for the actuary to calculate the actuarial values of the pre- and post-conversion benefits.
In turn, the actuary when calculating the actuarial values must use the assumptions chosen by the trustees, ignoring the value of any:
(i) benefits that have been commuted;
(ii) amounts that have been paid in respect of any benefits;
(iii) amounts in respect of any benefits that, before the conversion date, became due to be paid; and
(iv) discretionary benefits that might be awarded in the future.
Having calculated the required actuarial values, the actuary must supply the trustees with a certificate if the post-conversion benefits are, actuarially, at least equivalent to the pre-conversion benefits. The certificate must be provided no later than three months after the calculations have been completed.
Once converted, the members' benefits are no longer subject to the specific requirements applying to GMPs, such as the special rules governing GMP revaluation in deferment, GMP increases in payment, the restrictions on commutation and the requirement to pay the GMP at state pension age.
Survivors' benefits
To satisfy the requirement made by condition 4, the Contracting-out Regulations 1996 require that the following benefits must be payable:
- if the scheme member dies, whether before or after reaching normal pension age, leaving a widow, she is entitled to a pension of at least half the value of the pension to which the earner would have been entitled by reference to employment during the period from 6 April 1978 to 5 April 1997; and
- if the scheme member dies, again whether before or after reaching normal pension age, leaving a widower or surviving civil partner, he or she is entitled to a pension of at least half the value of the pension to which the earner would have been entitled by reference to employment during the period from 6 April 1988 to 5 April 1997.
In the case of a widow, widower or a surviving civil partner, the benefit must be paid during any period in which a category B state retirement pension is also payable to that person by virtue of the former spouse's or partner's contributions (or would be so payable but for rules governing persons entitled to more than one retirement pension). The benefit must also be paid during any period in which widowed parent's allowance or bereavement allowance is payable.
In the case of a widow, widower and a surviving civil partner whose entitlement by virtue of the scheme member's own contributions to a widowed parent's allowance or bereavement allowance has come to an end at a time after the widow, widower or surviving civil partner has reached age 45, the benefit must be paid to that survivor for so much of the period beginning with the time when that entitlement came to an end, provided that it is not a period:
- during which the survivor and either a person of the opposite sex are living together as husband and wife, or a person of the same sex are living together as if they were civil partners;
- which falls after the time of any marriage, or formation of a civil partnership, by the survivor which takes place after the scheme member's death; or
- for which a widowed mother's allowance or widow's pension is payable to the widow by virtue of the scheme member's contributions.
There are also some other specified circumstances in which survivors' benefits must be paid.
Survivors' benefits in practice
In essence, therefore, the circumstances and periods are the same for the payment of survivors' benefits as under the existing legislation on GMPs. Law firm Norton Rose observes that the reason that the requirement for survivors' benefits has been retained on conversion is that their removal could have given rise to claims under human rights legislation.
The legislation governing the minimum periods during which a GMP must be paid to a surviving widow, widower or civil partner, however, would not prevent the scheme rules allowing the payment of that benefit to continue for life. Given the complexity of these rules governing survivors' benefits (and indeed the difficulty for a pension administrator knowing when a survivor's pension could be stopped because the survivor was cohabiting), HSBC Actuaries and Consultants suggests that "a broad-brush approach, which is at least as generous, may be preferable."
Mercer also points out that the survivors' benefits under the ongoing contracting-out reference scheme test are not drawn as widely as the requirements for converted benefits so that it will not be possible directly to convert GMPs into reference scheme test benefits.
Procedural requirements
There is no requirement that the GMPs of all scheme members must be converted and indeed the trustees may decide to convert only on an individual basis.
The employer sponsoring the scheme must consent to any GMP conversion in advance. If the employer consents, the trustees must take all reasonable steps to consult the employees concerned in advance, and to notify all members and survivors affected by the GMP conversion before, or as soon as is reasonably practicable after, the conversion date. No consultation with employees is required, however, if the scheme has gone into wind up. Note that this consultation exercise is carried out by the trustees, and so the detailed requirements of the Consultation by Employers Regulations do not apply.
HM Revenue & Customs (HMRC) must also be notified by the conversion date that the GMP conversion is taking place, and must also be supplied with the details of the employees affected. In practice, the scheme's administrators may also need to reconcile their scheme's GMP records with those held by National Insurance Services to Pensions Industry, the section of HMRC dealing with contracting-out administration.
Transfers out
The 1993 Act contains a power to make regulations that set restrictions on the transfer of the earner's accrued rights under a GMP-converted scheme and/or conditions which must be observed on the transfer of an active or deferred member's accrued rights under a GMP-converted scheme. It is understood, however, that the DWP will probably not use this power because of the existing protection in place.
Where a member of a scheme that has not converted GMPs into accrued scheme benefits makes an application to transfer rights to another pension scheme, the trustees of the transferring scheme may, with that member's consent, adjust any guaranteed cash equivalent to reflect rights that would have accrued if the scheme had been subject to GMP conversion in accordance with conditions 1-4. When the trustees of a scheme are willing to make such an adjustment, the problem for the trustees of the destination scheme refusing to accept incoming transfers involving GMPs should disappear.
Powers to amend schemes
Under a power now included in the 1993 Act, the trustees may modify their scheme by resolution to effect GMP conversion (whether in relation to present earners, pensioners or survivors) in accordance with the conversion conditions. In such cases the subsisting rights provisions of s.67 of the Pensions Act 1995 will not apply so as to prevent GMP conversion, provided it is completed in accordance with the legislative conversion conditions. The alternative is for the trustees to use their scheme's power of amendment, but this would need to be certificated under s.67.
Where a scheme is amended to effect GMP conversion the trustees may include other amendments that they think are necessary or desirable as a consequence of, or to facilitate, the GMP conversion. Also, where an occupational pension scheme is being wound up, the trustees may, before the winding up is completed, adjust rights under the scheme to reflect what would have happened if the scheme had been subject to GMP conversion in accordance with conditions 1-4 set out above.
Enforcement
If the Pensions Regulator thinks that the conditions listed above have not been satisfied in relation to an amendment, modification or adjustment, it may make an order declaring the amendment, modification or adjustment void in respect of a specified person or class of person, to a specified extent, and as from a specified time. Any such order may be made either before or after such action takes effect. In the event that the regulator makes such an order it may require the trustees of the scheme concerned to take specified steps or declare that specified action by the trustees shall not be treated as a contravention of the scheme if it would not have been a contravention if the order had not been made.
Also, if the regulator thinks that the process of effecting a GMP conversion of a scheme has been commenced and that a relevant condition, as listed above, is not being met, or may not be met, it may prohibit the taking of further steps in the GMP conversion (whether generally or in relation to specified steps), and require the trustees of the scheme to take specified steps before resuming the process of GMP conversion. A civil penalty under the Pensions Act 1995 can be applied to a trustee who has failed to take all reasonable steps to secure compliance with the conditions.
The regulator has made it clear that it has no intention of offering any clearance process for GMP conversions.
Effect on Serps
Whether or not an employee's GMP is converted, a contracted-out deduction will still be applied to the employee's entitlement to additional pension from Serps in relation to any period of contracting out during which the employee accrued a GMP. If the employee after conversion becomes a deferred member in the scheme, the deduction will always be revalued in line with national average earnings.
Likely take-up
Mercer comments that its expectation is that "GMP conversion will not be a mainstream activity, at least initially." However, it says this is "something which most trustees will want to consider, if only to confirm that it is not right for them at the current time". Norton Rose believes that "in reality the costs of implementing the GMP conversion may not be rewarded sufficiently by lower expenses" and adds that "the fact that most schemes have not equalised GMPs to date and that confusion exists over whether a GMP needs to be equalised before it can be converted may be a sufficient deterrent in many cases."
Costs and savings of guaranteed minimum pensions conversion
"Whilst costs and benefits will vary significantly according to the circumstances of the particular scheme, for the purposes of making a broad indicative estimate of the possible effects of this reform, we have assumed an average initial cost of £7,000 for smaller schemes and £12,000 for larger schemes. Using an assumption that 25%-50% of schemes may choose to convert their GMPs, the total initial cost across all schemes is estimated to be between £11 million and £22 million, with a total annual cost saving of £6 million to £13 million.
Source: regulatory impact assessment, available on the DWP website (PDF format, 1K) (external website).
1 Occupational Pension Schemes (Contracting-out) (Amendment) Regulations 2009 (SI 2009/846), available from the OPSI website (external website).
2 Occupational Pension Schemes (Contracting-out) Regulations 1996 (SI 1996/1172), as revised.
Our research
Our research is based on s.14 of the Pensions Act 2007 (which inserts new ss.24A-24H into the Pension Schemes Act 1993), on the DWP's September 2008 consultation document on the draft Occupational Pension Schemes (Contracting-out)(Amendment) Regulations 2009, the government's response to that consultation published in February 2009, and the final Regulations that came into force on 6 April 2009. We have also drawn on commentaries from HSBC Actuaries and Consultants, Mercer, the National Association of Pension Funds and Norton Rose.
