While the end-goal of guaranteed minimum pensions (GMP) equalisation is clear – to equate the historical pension benefits for men and women – the related challenges, and opportunities, are less so.
Initiating and completing GMP equalisation involves many different stakeholders, from scheme members and trustees to company representatives and advisers. Companies and trustees should give careful consideration to how, and when, various stakeholders are involved to ensure the accurate and cost-effective equalisation of GMPs in their schemes.
Experience shows that individuals – especially retirees – are highly skeptical of any changes to their pension benefit, even if the change is good news. Communications need to be carefully worded and timed, to ensure members’ expectations are managed.
Governance issues may also arise if trustees and managers are distracted from important and impactful long-term strategic projects by the technicalities of GMP equalisation.
The direct financial impact of GMP equalisation on individual members is likely to be modest. For most people, their weekly pension may only go up by a few pounds, if at all. Add that up for the whole scheme, and this is not expected to be a game changer for the financial status of schemes. Indeed, there are opportunities that can be explored to reduce future liabilities and costs. That said, schemes must meet the legal obligations set by the High Court.
The number of members who will be impacted is very large, and issues of equality must be corrected however small the impact. Hence, the most tangible short-term financial impact will come from the amount of resource required to deliver this complex project. While much of the industry believes GMP equalisation will take 3 to 4 years, or more to complete, this is not truly necessary. With proper guidance and advice, it is possible to complete the process accurately and diligently within a much shorter timeframe. Companies should keep the pressure on trustees and advisers to ensure GMP equalisation does not drag on, acting as a distraction and building up costs.
A big decision for schemes is which method of GMP equalisation to adopt. It is a real fork in the road as the two main available methods – named ‘C2’ and ‘D2’– are very different.
Method C2 involves comparing a member’s relevant benefits with what they would have received if they were of the opposite sex. If payments to date would have been greater, with interest, the pension is uplifted. This method can be adopted unilaterally by the trustees, without involvement of the company.
A key advantage of the C2 method is that it reflects actual experience, rather than being based on assumptions of what is expected to happen, ensuring members receive the ‘correct’ benefit. In addition, the impact on the level and pattern of a typical member’s pension payments will be modest. However, schemes using the C2 method can also expect a more complicated and costly future administrative process, as essentially three sets of records must be kept for each member and additional comparison calculations will need to be done each month.
On the other hand, through method D2, schemes carry out a one-off actuarial value calculation at the outset. All GMP is converted into main scheme benefits, wiping away much of the historical complexity. Companies must give their consent to this method being used.
This simplification is a key advantage of method D2, making future pension administration more straightforward and cost-effective. The liability impact of method D2 is also likely to be lower. Indeed, the scheme will benefit from improved insurance pricing and opportunities for liability management exercises, the positive financial impact of which may go some, or all of the way, to offsetting the costs of GMP equalisation.
On the flip side, D2 relies on assumptions and value calculations, from which some members will ultimately ‘win’, whereas others will potentially lose out. D2 also represents a more material change to members’ benefits, which may be more complex to implement and to explain to members. No industry consensus exists as to which method is better, and further guidance is expected from various working parties – including DWP and HMRC. However, companies and trustees should engage early to ensure they understand the issues and proactively intervene to ensure costs are minimised and opportunities maximised.
Mark Williams is a principal and London retirement practice leader at Buck