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Media Briefing Note: Equalising the Effects of Guaranteed Minimum Pensions

25 January 2012

HEADLINES

  • The Government wants to force pension schemes to recalculate and adjust pension payments going back for over 20 years. 
  • The estimated cost to employers of doing this is in excess of £10 billion. 
  • The difference in benefits for individuals will be disproportionately small.  Most of the cost will go in the calculations and changing administration. 
  • It is unclear on how benefits should be adjusted to meet the requirements of European law. 
  • The Government has now issued draft guidance that suggests the most expensive way to equalise. 
  • The Government refuses to support a test case or to use a public sector scheme as a test scheme.

BACKGROUND

On 20 January 2012 the Department of Work and Pensions issued a consultation paper setting out a possible method to equalise the effect of Guaranteed Minimum Pensions (GMPs). 

GMPs relate to service prior to April 1997 under a contracted out defined benefit pension scheme.  Broadly, in return for the scheme providing a GMP as a substitution for a State Earnings Related Pension (SERPS) employers and employees would pay lower national insurance contributions.  Most defined benefit schemes (including those in the public sector) are contracted out and therefore have a liability to pay a GMP. 

As they are a substitute for the SERPS pension GMPs are payable from age 60 (women) and 65 (men) and women earned a higher level of GMP over a shorter period.  This inequality is a requirement of the legislation governing contracted out schemes so schemes must comply with it.  This produces minor differences between the pensions for men and women, reflecting the differences in SERPS. 

In May 1990 the European Court held that benefits under pension schemes must be equal as between the sexes.  It has been known since 1990 that GMPs were unequal but very few schemes have taken any action to equalise benefits.  Those that have were mainly winding up and made a token effort. 

In January 2010 Angela Eagle MP, the then Minister for Pensions announced that the Government considered that schemes should take action to equalise the effect of (unequal) GMPs.  When Steven Webb MP became the new Minister for Pensions he reviewed the position and announced in April 2011 that he would introduce legislation to make the need for equalisation clearer and stated that:

I wish to offer as much help as is practicable and so I have asked my officials to draft guidance on how a scheme might approach equalisation. 

It is this guidance that has now been issued by the DWP for consultation. 

COST OF ACHIEVING EQUALISATION

The Association of Consulting Actuaries has suggested that the cost of equalising the effects of GMPs will be in the order of £10 billion.  This cost is likely to be an underestimate if the DWPs suggested guidance is implemented.  A significant proportion of this bill will relate to public sector pension schemes such as the NHS, Local Government and the Teachers' pension schemes. 

COMMENTS ON THE GUIDANCE

The draft guidance gives little of the promised practical help and fails to deal with a number of significant issues that will arise with any scheme looking to achieve equalisation – for example how to equalise benefits for members who have already died or who transferred to another scheme. 

Perhaps the biggest criticism of the guidance is that it suggests a method of equalising benefits which is probably the most costly to the scheme (and therefore the employer).  It advises that a scheme reviews each payment made to a member and calculates whether the payment would have been higher if the member had been of the opposite sex.  The member should then receive the higher of the two payments. 

This produces a ratchet effect so that both men and women are required to receive increases to their pensions (at different times) to achieve equality.  The differences in payments are small.  In one example provided by the DWP over a 9 year period the underpayment to the man is £182 (under 40 pence a week) and for the women it is £435 (93 pence per week).  In practice the differences are likely to be even smaller than those in the DWP's simplified examples. 

The cost to schemes of recalculating pensions and dealing with the extra administration involved is likely to be very significant (perhaps even more that the additional benefit to be provided). 

There will be strong response from the pensions industry to the DWP's guidance.  To date the DWP has:

(a)  Resisted calls for it to sponsor a test case so that the Courts can give binding advice to schemes on how to equalise. 

(b)  Refused to equalise a public sector scheme such as the Teachers' Scheme and use that exercise to identify the real issues that arise in practice. 

CONCLUSIONS

The DWP guidance is of no help and produces a costly, overgenerous, result which is not legally robust.  The guidance is therefore not welcome.  If the DWP is so sure that it has the right approach it should equalise the Teachers' scheme – although HM Treasury may be concerned at the additional costs that will be incurred for public sectors schemes – particularly at a time when the Government borrowings have just exceeded £1 trillion. 

 
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