On 26 October 2018, the High Court confirmed in the Lloyds case that pension schemes are under an obligation to equalise Guaranteed Minimum Pensions (GMPs) for men and women.
Our recent Update, published on 29 October 2018, provides further detail on the background to GMP equalisation and the impact of the High Court judgment . This Update considers the particular impact the judgment will have on public sector pension schemes.
Most public sector pension schemes provide GMPs and, since the DWP first consulted on equalisation of GMPs in 2012, it has had one eye on new developments in relation to GMP equalisation.
In April 2016, contracting out using defined benefit pension schemes was abolished and the new single-tier State Pension was introduced. This caused another GMP-related issue for public sector pension schemes because it meant that the Additional Pension system was abolished. Under the arrangements that previously applied, public sector pension schemes and the Additional Pension system worked in tandem, providing a mechanism that fully indexed and equalised the overall pension payments (that is, the combined state pension and occupational pension) made to scheme members.
Since the removal of the Additional Pension system, the Government has implemented an interim solution to continue to price protect the GMP of public sector pension scheme members who reach state pension age after 5 April 2016 and before 6 December 2018. This was intended to ease the transition of those members to the new State Pension and to ensure that pension payments are not unequal between men and women.
However, this was only ever expected to be an interim solution and the Government knew that it needed to come up with a long-term solution so that it could continue to meet its obligations to index (price protect) and equalise (make equal payments to men and women) GMPs.
Government consultation on indexation and equalisation of GMPs
The Government ran a three-month consultation from November 2016 to consider what the permanent solution might look like. It considered a number of methods of achieving this. In its response, published in January 2018, the Government indicated that its preference for a long-term solution to GMP equalisation was to convert GMP into a non-GMP scheme benefit. This would avoid the long-term administration issues with trying to constantly measure and deal with inequalities in increases to GMP.
However, the Government knew that the Lloyds case was awaiting judgment and so it decided to wait for the outcome of the case before considering this any further. As a stop-gap, it decided to extend the interim solution so that it applies to members who reach state pension age on or before 5 April 2021.
What does the Lloyds case mean for public sector schemes?
The Government's stated preferred method of converting GMP into a non-GMP scheme benefit was one of the methods of equalisation that was considered and approved by the High Court in the Lloyds case (after a one-off equalisation and actuarial equivalence test had been undertaken) as a way of dealing with GMP equalisation.
As this is a High Court decision, it could be appealed, although there is no indication at this stage that an appeal will be brought. Should the Lloyds case not be appealed in the coming months, the Government's preferred methodology as described in the consultation response may still be the best option for the equalisation of GMPs within public sector pension schemes.
The Government has said that it will use the extension period granted by the interim solution to consider the adoption of conversion as a longer-term solution for GMP equalisation and that it will continue to consult with departments and schemes to decide whether a suitable conversion method and legislation can be implemented.
The costs involved in equalising for GMP purposes will depend on the circumstances of the individual scheme and method used but, according to estimates from the Government Actuary’s Department, the liabilities of public sector pension schemes will increase by up to £5bn.
Whilst we wait to see whether the Lloyds case will be appealed and await any further information from the Government as to how it plans to further consult on GMP equalisation for public sector pension schemes, it is essential to keep this case in mind when considering issues such as public sector pension scheme contracts.
Our expectation is that the additional costs associated with equalising GMPs will be passed on to employers unless some other mechanism can be found.
For example, it is unclear whether the additional costs could be treated as falling within the “employer cost cap” (which is intended to protect against unforeseen changes in scheme costs and provide backstop protection to the taxpayer) for the teachers', NHS and civil service schemes. Current calculations show that there is a surplus of cost in these schemes, which will lead to an improvement in member benefits. Adding in the cost of equalising GMPs may mean that the surplus of cost is eroded. The Government will no doubt need to take advice on this, and the trade unions will have their opinions. Our Update published on 14 September 2018 has more information on the employer cost cap.
In the LGPS, the immediate issue will be how the cost of GMP equalisation is captured in employer contributions as these are largely set individually for employers, unless they are pooled with other employers. Employers and admission bodies will have to examine what protection (if any) they have against those rising costs in their commercial contracts. Those who are having a cessation or exit payment calculated for them in the coming months will need to check that there is no residual liability if GMP equalisation is conducted after the cessation or exit debt has been paid.
If you have any questions about the impact of this judgment or wish us to take a look at any public sector scheme contracts you have or may be entering into in future, please do not hesitate to get in touch with your usual pensions team contact.