GMP equalisation and the route to buyout
18th March, 2021
The issue of GMP equalisation is likely to be engaging the trustees of all previously contracted-out schemes. It is much more pressing, however, for schemes which are considering a buyout in the short to medium term.
A few insurers, more specifically those involved with larger transactions, are already able to offer GMP equalisation via a dual records approach, subject to a loading on the administration premium. The remainder, however, are still developing their offerings, and it is likely that these will take a couple of years to be fully realised and on offer as a standard approach to pension schemes of all sizes.
The current default GMP equalisation approach on buyout is therefore conversion, for sub £500m schemes at least, although this will change in time as insurers are able to offer additional flexibility.
Given the relatively small amount of time elapsed since the Lloyd judgments, and the lack of clarity on some points of detail, none of the insurers active in the bulk annuity market expect pension schemes to have completed a GMP equalisation exercise prior to a market approach; schemes which have done so will be more attractive, as there is less chance of significant changes in the data being required post transaction.
Conversion of GMP benefits at retirement is not attractive to insurers and they generally will not be able to accommodate this within a bulk annuity contract. This does not mean that trustees cannot follow this approach while the scheme is ongoing – however, the position for the remaining members would have to be resolved prior to buyout. A number of schemes may be considering whether it is appropriate to run a pension increase exchange (PIE) exercise alongside GMP conversion, as this could be a cost-effective way to give members flexibility on how their benefits are structured. This is quite difficult for insurers to offer post transaction, and so an exercise of this kind should ideally be completed before going to market.
For any trustees with strong views on acceptable GMP equalisation methods who wish to complete a buyout reasonably quickly, it is important to engage with the bulk annuity market to understand where insurers are at now, and also the timeframe for future developments. Understanding a scheme’s membership profile is equally important – for example, the size of the scheme, the employment sector, size of remuneration and pension benefits will strongly influence the likelihood of members having opted for fixed protection, making GMP conversion more problematic. This is the fundamental problem with GMP conversion – there are too many ‘known unknowns’ from a pensions tax perspective. A new industry group has been set up to look at possible solutions to the tax issues.
As there is an expectation that dual records will be available from all insurers eventually, a compromise could be for schemes to secure a policy and complete the post transaction implementation on a basis which excludes GMP equalisation. This may be less attractive for schemes holding policies which cover the whole membership as it delays a buyout and eventual wind up – although work can be undertaken in the interim to build member records as required to support the chosen equalisation method.
The above option offers maximum flexibility, at the cost of additional risk both in respect of the timescale to buyout and also the pricing basis for any benefit alterations. These will be costed on the prevailing pricing basis for the insurer at the time the changes are made rather than the pricing basis at inception, which would be the case if the adjustments were applied as part of the initial implementation stage.
The preferred position for each scheme will be very much dependent on the specific circumstances – it is important for trustees to be clear on their ultimate objectives so that they can ensure the contractual terms for a bulk annuity policy are sufficiently robust. Insurers will want to be copied in to the legal and actuarial advice issued during the process, and will want to understand where approximations have been made if full data is not available; but they do not generally expect to provide any input into the calculations.
Negotiation with insurers is possible in respect of schemes where a policy was secured some time ago but a buyout has not yet been completed. We are seeing a good degree of pragmatism if trustees are able to clearly articulate their requirements and the reasons behind these. As ever, having the right governance structure in place will deliver the best results for the members and the scheme.