The Treasury has decided to abandon the idea of converting guaranteed minimum pension benefits in public sector schemes, opting for a permanent extension of full indexation, which will be more expensive for private pension funds that are forced to mirror government rules.
In its response to the GMP indexation consultation published on Tuesday, the government announced it will discount conversion as a long-term policy solution. Public sector schemes will need to provide full indexation to public servants with a GMP reaching state pension age beyond April 5 2021.
Conversion has been floated as a solution to difficulties around inflation-proofing contracted out benefits. A temporary fix was introduced in 2018, which granted full indexation of GMPs for those reaching normal retirement age before or on that date.
Between 1978 and 1997, employers sponsoring defined benefit pension schemes could contract their employees out of the additional state pension, as long as the scheme paid a comparable GMP.
Many private sector workers may feel that it is unfair that they have lost out on part of their inflation protection in retirement
Steve Webb, LCP
But existing legislation, due to the introduction of the new state pension in 2016 and the abolishment of the second state pension, means the government needs to continue to meet its obligations to index (price protect) and equalise (make equal payments to men and women) these pension entitlements in public sector schemes.
The consultation, published in October, presented three solutions: another temporary extension of indexation; a permanent extension of indexation; or an alternative model — GMP conversion — which would see public servants’ GMPs converted into normal scheme benefits.
‘Most practical solution’
Treasury officials said in the consultation response that a permanent extension of indexation was the most practical solution for the problem.
“This is because before conversion could be undertaken, schemes would need to ensure that they have accurate reconciled data, along with a finalised methodology to convert those GMP benefits where conversion on a £1:£1 basis would not result in equalisation.”
This would be “resource intensive” at a time where public sector schemes do not have the capacity to undertake conversion until at least 2024, and there is a chance that it might not be deliverable by then, the document read.
The government also noted that existing legislation was not appropriate for public sector schemes to undertake conversion, and that the benefits of this route for public servants who have not yet reached their state pension age “diminish over time, as the number of these members is steadily reducing”.
Nevertheless, the Treasury recognised that there would be benefits to undertaking conversion, which would include a reduction in administrative complexity in the long term regarding those public servants yet to reach state pension age.
Some respondents to the consultation also highlighted that this option would make the system more transparent as it would be easier for members to see how their benefits have been derived.
Private sector schemes caught by government decision
In some cases, such as BT — where the company was once state-owned and is now privatised — changes to public sector pensions can have a direct knock-on effect on private companies.
BT took the government to court in 2018 after the Treasury announced its temporary fix of full indexation in 2018.
As reported by FTAdviser at the time, while the protection of GMP by indexation was estimated to cost the government £5bn, BT would also be left out of pocket because of its ties to the civil service pension scheme from the days before it was privatised.
It was estimated that, had its appeal to the courts been successful, the verdict would have seen the cost to BT of members’ benefits fall by about £120m, translating to an average loss of £15,000 for each affected member.
Respondents to the consultation also noted a similar situation with the University Superannuation Scheme and the Royal Mail Statutory Pension Scheme.
Despite the detailed advantages of the conversion route, the government did not consider these “to outweigh the benefits of making full indexation the permanent solution”.
GMP ruling implementation will be ‘Herculean’ task for schemes
A ruling on guaranteed minimum pension equalisation will see trustees having to revisit 30 years of pension transfers, which will be a “Herculean” task for administration teams amid missing data and poorly kept records.
Former pensions minister Sir Steve Webb, now partner at LCP, noted that the announcement will be “good news to millions of public sector workers who will see their inflation protection in retirement secured”.
“But many private sector workers may feel that it is unfair that they have lost out on part of their inflation protection in retirement.
“Although many of these workers will still have very good pensions, and some will get more at retirement from the new state pension arrangements than the old ones, there may be ongoing resentment that the government has done more for public sector workers.”
