In this month’s Pensions Extra we look at the DWP’s consultation on draft regulations and possible method for equalising guaranteed minimum pensions (GMPs). The much-anticipated consultation confirms the Government’s view that there is a legal obligation under UK and EU law to equalise in respect of GMPs and also suggests a possible method for equalising GMPs which is at the more complex and costly end of the methods available.
GMPs arose in pension schemes contracted-out on a defined benefit basis between 6 April 1978 and 5 April 1997, providing a guaranteed minimum level of benefits based on the amount the pensioner would otherwise have received from the state earnings-related pension scheme. GMP rules provide that GMPs are payable from age 60 for women and age 65 for men.
On 17 May 1990, the European Court of Justice (ECJ) determined that occupational pensions were a form of deferred pay and as such occupational pension schemes had to provide equal benefits to men and women (the Barber judgement). This obligation under EU law is reflected in the Equality Act 2010 which deems a “sex equality” rule into the rules of all occupational pension schemes.
Whilst most scheme members accrue benefits in excess of the GMP minimum, the different GMP regimes for men and women can result in a difference in treatment. That said, it has been unclear whether and how GMPs should be equalised. Some have argued that GMPs are simply a calculation factor and therefore do not require to be equalised, others have argued that they are a specific defined benefit entitlement. Industry calls for a test case to the ECJ to settle the position have been ignored and in the absence of formal guidance, most schemes have opted to “wait and see”.
DWP consultation paper and draft regulations
The DWP’s position on equalisation of GMPs is set out in the consultation paper:
- It has always been the Government’s position that the obligation to equalise overall scheme benefits included inequality arising from the GMP rules in respect of accruals from 17 May 1990 to 5 April 1997, where a comparator existed. The obligation to equalise “flows from Barber and current domestic legislation”.
- The ECJ’s previous decision in Allonby (2004) is authority for the position that because the inequality resulting from the GMP rules results from legislation, there is no need for a comparator.
- Schemes are therefore legally obliged (and have been since the Barber judgement) to equalise GMPs and assume that a comparator exists for that purpose.
In order to implement the DWP’s position, the Regulations amend the legislation so that a member of an occupational pension scheme may benefit from the deemed “sex equality” rule without the need to identify a comparator.
DWP proposed equalisation method
The DWP’s consultation paper acknowledges the uncertainty in the pensions industry around how to amend benefits to equalise for the effect of GMPs. In an attempt to assist, the DWP provides “one possible method” for equalising GMPs – although it caveats that there is no obligation on schemes to use the method and that, if published, it would not constitute legal advice on how to equalise. Trustees will be free to take such action as they feel appropriate to meet their legal obligations in respect of GMP equalisation.
The DWP’s proposed equalisation method requires an additional calculation to be made to compare what a member would get under the scheme rules and legislation if they were treated as a member of the opposite sex. The member’s benefits should then be the higher amount. The comparison calculation would be made each time the amount of pension in payment is calculated (usually annually).
So, at each calculation date there would be a calculation under the scheme rules and legislation to assess the amount of benefits (i) a member and (ii) a “notional opposite sex comparator” accrued between 17 May 1990 and 5 April 1997 considering both the age at which the member and comparator would start being paid a pension and the amount of overall pension the member and comparator would be paid.
Consequences and issues
The DWP has not provided an impact assessment at this stage. Some commentators have suggested the costs of equalising could be £10 billion if following the DWP’s method and £5 billion using other methods. On top of that would be administration and advice costs. The costs are increased by the requirement of the DWP’s proposed method to carry out equalisation calculations on an annual basis. It is likely that these costs will hugely outweigh the value of any additional benefits payable to scheme members.
While the DWP’s proposed equalisation method is clearly stated to be just one of many possible methods, it is likely to become the default as it is endorsed by the DWP. It has been argued that the DWP’s proposed method is unnecessarily “gold-plated” and that a one-off test focused on overall value rather than pension paid each year would be more appropriate, being both simpler and cheaper. It is notable that the PPF has adopted a one-off test approach in its ongoing GMP equalisation pilot programme. It will be interesting to see which method the Government adopts to equalise the public sector pension schemes.
The DWP has ruled out a test case in order to obtain a definitive answer to the issue of whether there is an obligation to equalise GMPs, and if so how that should be done. Without such a case, the DWP’s position may be open to challenge and it may remain unclear what EU law requires. This could leave schemes’ GMP equalisation attempts open to challenge in the future.
The consultation runs until 12 April 2012 and it is expected that the implementing Regulations will come into force later this year. We will keep you up-to-date with developments on this issue.