Most pension schemes expect to combine their guaranteed minimum pension rectification and equalisation projects, new data suggest, as experts said this can simplify member communications and increase efficiencies for trustees.
Three quarters of the schemes advised by consultancy Buck that contracted out of the state earnings-related pension scheme are set to bundle the two tasks, although this position could change as result of industry guidance or a significant delay in the GMP equalisation process.
Contracting out meant defined benefit schemes could avoid their members tripling up on pension benefits by building up a basic state pension, Serps, and an earnings-related occupational pension. In exchange for giving up the Serps, both employee and employers paid less national insurance contributions.
In 2016, HM Revenue & Customs discovered that some pensioners had been paid contributions to their NI when in fact they were contracted out. The difference in records led to over and under-payments, and schemes were urged to reconcile their records with the taxman before rectifying incorrect payments.
Many trustees are concerned about the costs of implementing both GMP reconciliation/rectification and equalisation, which may be disproportionate to the adjustments that are required
Robert Thomas, Law Debenture
Two years later, the High Court ruled Lloyds Bank scheme trustees must equalise benefits between women and men who have GMPs because of contracted-out benefits, putting to bed an open question stemming from the famous 1990 Barber case on equal treatment in pensions.
The majority of schemes are well through the reconciliation process, but have not started the rectification part of this project, and must now take action on equalisation.
Combining tasks avoids member confusion
Mark Williams, principal and London retirement practice leader at Buck, is an advocate for combining the two projects in one. Mr Williams, who is also a member of the Pensions Administration Standards Association’s GMP equalisation working group, explained that for pensioners schemes will have to rectify and equalise GMPs, and there is “an awful lot of commonality in the calculations – they both involve a rollback of those pension amounts to determine back payments and corrections”.
By approaching it as a combined project, trustees only have to go through that calculation once, he added.
Another significant advantage is from a communication perspective, as it will be “extremely difficult to explain to members” the changes in their benefits due to GMPs.
Mr Williams said: “By giving [members] one communication that sums this up as a single change to their pension benefits, and even better if that coincides with a pension increase – which we expect to happen in most circumstances – you can tell them what the changes are.
“A related advantage... is when the impacts will work in opposite directions. You can have a scenario where a member’s pension should be going down due to rectification, but then it will need to come up again due to equalisation, which is extra confusing for the member, and extra inefficient if you are doing that separately.”
Cost savings on offer
Robert Thomas, a trustee director at Law Debenture and member of the PASA GMP Equalisation Working Group, noted that many trustees are concerned about the costs of implementing both GMP reconciliation/rectification and equalisation, which “may be disproportionate to the adjustments that are required”.
He said: “Trustees will quite rightly look for ways to manage the cost - that may argue for a single combined adjustment. That said, trustees will be mindful that some members are receiving less pension than they are entitled to and will want to put this right as soon as they can.”
Simplified GMP example
A pensioner in their 70s, retired around 10 years ago, with a current pension of £10,000 per year, of which £2,000 is GMP (partly built up between 1990 and 1997).
With separate exercises:
The HMRC reconciliation process suggests a lower GMP amount of £1,900 per year.
The trustees reduce the member’s pension to £9,900 per year and reclaim £1,000 of overpayments from the member.
Later, it turns out the member is set to benefit from GMP equalisation. The post-equalisation pension is £10,100 per year, including a higher GMP amount of £2,200.
The trustees increase the member’s pension to £10,100 per year and pay them £2,000 of back payments.
With a combined exercise:
The reconciliation and equalisation exercises reveal the same impacts as above, but the trustees take no action until both exercises are complete.
The trustees increase the member’s pension to £10,100 per year and pay them £1,000 in back payments.
Source: Buck
He added: “I like the idea of doing some analysis to identify members for whom significant adjustments are expected from either exercise. If there are not any, I would look for the most cost-effective approach – probably a single adjustment for both. But if there are, I would want to see if we could accelerate putting things right.”
Mr Williams explained that there are also advantages of doing two separate projects, particularly if the trustees are aware that the member is receiving the wrong benefits.
“The position may well be that you have a fiduciary duty to update and correct that member’s benefits as soon as it is practical,” he said.
PASA’s working group has recognised this dilemma, and will issue specific guidance on this point in the first quarter of this year, he added.
Mr Williams expected the guidance to be an extension of what was referenced in a call to action documents issued in July 2019, which did not favour a specific approach but did set out some pros and cons of both.
