The Treasury has indicated it may axe guaranteed minimum pension conversion in a new consultation, with experts citing administrative costs as a reason to ditch the idea.
The proposal, outlined in a paper looking at solutions for people reaching state pension age after April 2021, would see GMPs equalised as required under law, but kept separate from main benefits.
Coversion has been floated as a solution to difficulties inflation-proofing GMPs. A temporary fix was introduced in 2018, which has been estimated to cost £5bn and 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.
The government will now have to decide whether to come back to the conversion option in years to come or whether simply to make this temporary fix a permanent one
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 document presents three potential 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.
A temporary extension, similar to the one that was introduced in 2018, would cover all those reaching state pension age at or before April 5 2024.
“[This] would allow time for government departments and scheme administrators to complete their existing programmes of work, reconsider conversion as a long-term policy solution, and implement conversion for members reaching state pension age after April 5 2024, should conversion be the chosen long-term solution,” the consultation stated.
By contrast, a long-term extension covering a period up until 2030 would accomplish much the same as the first option, with the “additional benefit of also providing schemes with capacity to address any unforeseen pressures arising between now and 2024”, the document read.
The long-term extension would still be time-limited, with the option for a permanent extension being a corollary of the government’s third proposed solution: discounting the idea of conversion as a long-term policy solution.
Conversion off the table?
With a number of costly and time-intensive issues already affecting public sector pension schemes, such as the McCloud remedy, it is thought the government is keen to steer away from the conversion route, previously explored in a consultation between November 2016 and February 2017.
Under conversion, the new consultation document explained: “A public servant’s GMP is converted into a normal scheme benefit, usually on a £1:£1 basis, which would mean that the GMP would no longer exist.”
But because of the work involved in implementing that approach, experts predict that the government will favour an alternative solution, whether that be a temporary or a permanent extension of the current indexation approach.
The consultation document itself stated: “The main cost of conversion is the administrative work required to implement it. This cost remains significant, in particular for setting up the systems, no matter how few members are converted.
“At some point, these setting up and related operational costs will outweigh the benefits of conversion.”
Indeed, the government’s consultation document warned that because of the significant workload already placed on public sector pensions, implementing GMP conversion would probably not be achievable before the end of the interim solution in April 2021, and may not be implemented until April 2024 “at the earliest”.
It also warned that the longer indexation is extended, the smaller the benefits — and the greater the comparative costs — of indexation will be.
Steve Webb, former pensions minister and partner at LCP, told Pensions Expert that the new consultation reflects the continuing consequences of a move to a new state pension system in 2016.
He said: “The government must have hoped that they could move to a permanent solution having put in place a temporary ‘fix’ since 2016. But the administrative pressures on public sector schemes to deal with the McCloud judgment mean their capacity to do major benefit restructuring at the same time is very limited.
“The government will now have to decide whether to come back to the conversion option in years to come, or whether simply to make this temporary fix a permanent one.”
David Robbins, senior consultant at Willis Towers Watson, took to Twitter to suggest that an administrative headache might be a price worth paying, considering the potential savings conversion could offer to the taxpayer.
He favoured a case-by-case approach, previously considered by the government in the previous consultation. This solution compares the total income that would be received by the pensioner each year from public and state pension provision, under the old and new systems.
Where the member’s total income from these sources that year is lower than it would have been under the old system, the member would be compensated that year. This compensation would only be up to the value of the loss of GMP indexation.
“The method would only have compensated public sector scheme members who had actually lost out, not those who gained overall,” Mr Robbins wrote.
“[The Treasury] ruled this out, saying it was ‘administratively complex’. The prospective £3.5bn saving to taxpayers might have been worth some admin hassle.”
But ITM’s chief innovation officer, Maurice Titley, told Pensions Expert that conversion of GMPs for post-April 2016 members “is more complex than at first sight, because you need to take account of the fact the GMP can act as a minimum pension increase difference”.
“This mirrors what we are seeing for private sector GMP equalisation where the detail of GMP conversion can become off-putting.”
Knock-off effect on private schemes
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 as an average loss of £15,000 for each affected member.
A BT spokesperson told Pensions Expert that it is reviewing the new consultation.
New GMP guidance stops short of clarifying rules around conversion
New guidance on guaranteed minimum pensions has clarified the tax implication of equalising past inequalities between men and women, but critics have said it leaves unaddressed important questions for schemes hoping to convert GMPs into regular scheme benefits.
“In the private sector, however, the costs and benefits of conversion are being weighed against those of other GMP equalisation methods — whereas in the public sector it looks like the full indexation approach is becoming inevitable, as a 1:1 conversion would offer little eventual benefit in terms of a reduction in costs to the public purse,” Mr Titley explained.
“2021 has come very quickly. Worries about McCloud and other rectification work taking admin resources leaves little air time for conversion work on top of that. Legislative guidance is getting stuck in the private sector [tax treatment for GMP conversion]. Full indexation is therefore a route of least resistance.”
