Guaranteed minimum pension (GMP) conversion offers the opportunity for defined benefit schemes to simplify their benefits, potentially saving costs and making schemes more attractive to be bought out with an insurer.
One of the great unanswered questions of pensions law has finally being answered. In October last year, the High Court in the Lloyds Bank case determined that pension schemes have to equalise for the effect of GMPs. As part of the judgment, the Court confirmed the effectiveness of the GMP conversion legislation issued by the Department of Work and Pensions (DWP).
Also, in a follow-up judgment, the Court confirmed that GMP conversion, known as the “D2 method”, can be used as a route to achieve equalisation. This effectively allows a scheme to pay the higher of two amounts, based on the value of the member’s GMP and an opposite sex comparator’s GMP, rather than run on dual records for service between May 1990 and April 1997.
Many employers and schemes are now looking at equalisation for the effect of GMPs and whether GMP conversion is part of the solution. Conversion needs to be agreed by both the employer and trustees.
On 18 April 2019, the DWP produced useful guidance on the process for conversion of GMPs into ordinary scheme benefits. This provides some more detail on the 10-stage plan to follow the statutory process.
The guidance highlights that are some difficult questions for schemes to look at including whether to convert now for active, deferred and pensioner members. For active and deferred members, the decision to convert is a lot more complicated. It also touches on how to deal with gaps in data and what to do about correcting past benefits for pensioners who have been underpaid.
Opportunities to simplify
When converting benefits, the DWP guidance highlights that schemes may want to consider looking beyond simply converting GMPs in such a way that removes discriminatory treatment. There is an opportunity to simplify further, moving away from CPI-linked increases for GMPs in payment to RPI-linked increases or potentially flat increases.
There is some scope within the GMP conversion legislation to allow for more significant changes, but important constraints remain. The extent of the amendment power in the legislation is unclear. In addition, surviving dependants’ pensions have to be paid as part of the benefits and a pension in payment cannot reduce in value following conversion.
Not the end of the story
Whilst this appears to offer significant opportunities for employers and trustees to explore, further developments are awaited. Schemes still need guidance from HMRC on the potential tax implications of equalising and converting GMPs. Also, there are some planned changes to the conversion legislation that are expected, and some unanswered questions on past transfers and the taking of a more pragmatic approach to equalisation where the costs to the scheme outweigh any upside to members.
Conversion needs to fit into the wider plans of the scheme. If a scheme is looking at buying out benefits with an insurer, simplifying the benefit structure may lead to more competitive pricing.