The UK Department of Work and Pensions (DWP) released the long-awaited “Guidance on the use of the Guaranteed Minimum Pensions (GMP) conversion legislation” on April 18, 2019. Historically, GMPs could create an inequality in the total benefits a man or a woman received under similar circumstances. Over the past few decades, the UK government has determined that pension schemes must equalize pensions to resolve those inequalities, though there is not a specific method that is required to reach that equalization. Specifically, equalization must be achieved for benefits accrued between May 17, 1990 and April 5, 1997.
The DWP has outlined a process to equalize these benefits and use existing GMP conversion legislation to convert the equalized amounts into a non-GMP pre-97 pension. The calculation method outlined relies primarily on the equalization and conversion method referred to in the court case as Method D2. Many in the pensions industry are moving towards adopting the D2 method. At first sight, the process appears simple:
- Define the value of the pre-1997 benefits payable (including attaching survivor benefits) based on the member’s actual sex. The DWP refers to this value at the date of conversion as “Amount A”.
- Define the value of the pre-1997 benefits payable (including attaching survivor benefits) as above, except for the period May 17, 1990, to April 5, 1997. The GMP entitlement is calculated as if the member were of the opposite sex, with the pre-1997 excess benefits being adjusted accordingly. The DWP refers to this value at the date of conversion as “Amount B”.
- The higher of Amount A and Amount B is then converted into a pension using the same valuation basis. Ideally, the format of the selected converted pension should be similar to that of the scheme pension it replaces.
The calculation of Amount A and Amount B should be relatively straightforward to anyone who calculates Cash Equivalent Transfer Values or undertakes Transfer Value Comparator valuations etc. The valuation software will need to accommodate deceased members and/or members who have already received their pension and convert the past and future shortfalls into the appropriate combination of lump sum and future pension. For those familiar with the Pensions Review calculations of the late 90s, something akin to the case types ‘Prospective Loss on Opt-Out’ and ‘Actual Loss on Opt-Out (retirements and deaths)’ will need to be accounted for.
Because members may place a low value on distant benefits, they may have difficulty recognizing that the post-conversion pension is an equivalent value to the higher of the male/female pension payable. One way to counteract this perception is to front-load the post-conversion benefits payable. For example, when possible, pay lump sums equating to the higher of the male and female benefits accrued to date, and choose modest pension increases to maximize initial post-converted future pensions. The DWP guidance acknowledges, however, that as the Actuary sets the format of the post-conversion benefits, the benefits:
- must be actuarially at least equivalent to the pre-conversion benefits
- must include survivors’ benefits in accordance with the provisions of the Act and Regulations
- for pensions in payment, the amount of pension to which a member had an immediate entitlement before the conversion must not be reduced as a result of the conversion
The guidance goes on to acknowledge that, in some circumstances, it may be appropriate to give the member some options in terms of the post-conversion benefit format.
SS&C offers software solutions for the life and pensions industry through Pensions & Actuarial Services Ltd (PAS). Our illustration, financial planning, and transfer value analysis solutions help you provide comprehensive and personalized advice to your clients. These tools can be used to show pension scheme members their options when appropriate, and help them understand the full scope of the conversion to their pensions. PAS’s Defined Benefit valuation software has been deployed extensively to calculate redress for UK scheme members since the late 1990s.
Written by Robert Dean
Principal Technical Manager, Pensions & Actuarial Services