Article by the pensions team
Originally Published 29th October 2008
Overview
The Pensions Act 2007 ("the 2007 Act") contains provisions permitting contracted-out occupational final salary pension schemes to convert members' Guaranteed Minimum Pensions ("GMPs") into ordinary scheme benefits on the basis of "actuarial equivalence".
The draft Occupational Pension Schemes (Contracting-out) (Amendment) Regulations 2009 ( "the draft Regulations") were issued on 2 September 2008 as a consultation document by the Department for Work and Pensions ("DWP"). The draft Regulations clarify the conversion conditions which need to be met to achieve "actuarial equivalence" and are intended to come into force on 6 April 2009. The consultation period closed on 28 October 2008.
Procedural Steps
The 2007 Act specifies that the following procedural steps must be complied with before conversion can take place:
- Although the trustees must initially decide that they want to convert GMPs, the employer must give its prior consent.
- The trustees must take all reasonable steps to consult the relevant members in advance of the conversion, and give such members the opportunity to make representations to the trustees.
- The trustees must notify all affected members and survivors before or as soon as reasonably practicable after the conversion date.
- HMRC must be notified on or before the conversion date.
Actuarial Equivalence
The draft Regulations make the trustees responsible for determining actuarial equivalence. Trustees must obtain advice from the scheme actuary about which assumptions should be used and must then decide, having considered the actuary's advice, which assumptions will be used.
In order to achieve actuarial equivalence, the actuary must compare the actuarial value of members' benefits before and after the proposed conversion using the trustees' chosen assumptions, and must ensure that the value does not decrease as a result of the conversion. In making the actuarial equivalence calculations, the actuary must ignore the value of any:
- benefits that have been surrendered, commuted or forfeited;
- amounts that have been paid in respect of any benefits;
- amounts in respect of any benefits that became due to be paid before the conversion date;
- discretionary awards that might be awarded in the future.
The actuary must send the trustees a certificate confirming that actuarial equivalence has been achieved.
It should be noted that while conversion will allow schemes to discharge their liability for paying GMPs, the general legislation that governs scheme benefits ( eg revaluation, equality) will apply to converted benefits. Additionally, accrued final salary benefits cannot be changed into money purchase benefits.
Survivors' Benefits
The draft regulations provide that on conversion, the scheme must provide survivors' benefits in the same circumstances and for the same period as currently applies under existing GMP legislation – ie half of all GMP rights accrued from 1978 to 1997 where the member leaves a widow, and half of all GMP rights accrued from 1988 to 1997 where the member leaves a widower or surviving civil partner.
Consultation Guidance
The DWP consultation document gives guidance on how the conversion process might work although it is emphasised that the guidance has no legal force. The guidance picks up the provisions of the 2007 Act, and some of the main points covered are as follows.
Initial Considerations
Having made a decision to proceed with conversion, the trustees need to decide which liabilities will be converted. They could decide - eg - to convert liabilities for deferred members only. In making a decision, anti-discrimination legislation needs to be considered.
The trustees will also need to decide what the GMPs will be converted into and how this will be factored into the scheme rules. The 2007 Act gives trustees power to amend their scheme rules by resolution to achieve conversion, and provides that the subsisting rights provisions of section 67 of the Pensions Act 1995 do not apply to conversion.
Member Consultation
The guidance states that the legislative requirement for the trustees to take "all reasonable steps" to consult affected members is specifically not defined as this will vary depending on the circumstances. In particular, the undefined term is intended to assist schemes which, after making reasonable attempts, are unable to contact some members.
It is suggested that it may be helpful for the consultation to include an estimate of the converted benefits for each member so the effect of conversion is clear.
After the end of the consultation period, the trustees will need to consider any responses and make a decision whether to proceed with conversion or not.
The Conversion Process
To commence conversion, the scheme must establish each affected member's GMP entitlement. The guidance notes that it is assumed that this may involve requesting reconciliation of the scheme records with the information held by the National Insurance Contributions Office ("NICO").
The guidance states that, in preparing the calculations, the actuary may use the same method for conversion as the scheme uses for calculating transfer values. If so, the trustees will need to specify an assumption for when active members will leave pensionable service as this will affect the calculations.
After conversion, it is expected that members will be notified of their new benefit and HMRC notified of the members whose benefits have been converted. The trustees will be discharged of their liability to pay GMPs, provided that the conversion has been done in accordance with the legislation.
Equalisation
Although GMPs are unequal as between men and women, the guidance emphasises that post-conversion benefits must comply with the law relating to equalisation for benefits accrued from 17 May 1990. Conversion may, therefore, provide a solution to outstanding GMP equalisation issues as it is still not clear how schemes should treat GMP equalisation. There will, however, be cost implications which will have to be taken into account.
Regulation
Members may complain to the Pensions Ombudsman if they do not agree with the way conversion has affected their position – eg because the replacement benefits were incorrectly calculated.
Additionally, the Pensions Regulator has been given the responsibility for overseeing the conversion process and will be able to consider member complaints in particular in respect of:
- the proper conduct of the consultation process; and
- the actual conversion on the basis of actuarial equivalence.
The Regulator will be able to prevent the conversion from proceeding while any complaints are investigated, and will also be able to require schemes to rectify any deficiencies and in extreme cases order the trustees to "unpick" the conversion.
Transfers
Where an individual wishes to transfer his benefits to another arrangement, the legislation will allow conversion of his GMPs on an individual basis if the scheme wishes to offer this option.
Contracted-out Deduction
On conversion, it will still be necessary to make the deduction from the relevant social security benefits in order to prevent double provision. NICO will calculate a notional GMP for members whose benefits have been converted, and will apply the same contracted-out deduction as would have applied if conversion had not taken place.
Comment
Although GMP conversion may seem to present an attractive option, the complexity and cost involved may prevent schemes from proceeding with a conversion exercise. In particular, the need to provide equalised benefits postconversion will undoubtedly increase the expense which in the current economic climate may not be viable for the majority of schemes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.