 By Kate Payne, Partner and Max Ballad, Legal Director from Arc Pensions Law LLP
While the decision primarily affects public service pension schemes, it also impacts a small number of private sector and other schemes. The affected schemes include those whose rules mirror the public sector provisions because they were originally sponsored by a nationalised industry such as Royal Mail or BT.
Past governments gave unequivocal commitments to public servants that their guaranteed minimum pensions would continue to increase in line with price inflation each year. These increases were met through combining increases in the state pension with additional increases made through the public service scheme. However, the 2016 introduction of the new state pension simplified the state pension system, but impacted the mechanism through which the public service schemes were index linked.
Up until 5 April 2016, a useful arrangement which existed to meet the government’s GMP commitments to members whose pensions were contracted-out through their membership of schemes in the private sector. Essentially, this arrangement saw the additional earnings-related part of the state pension increased in line with inflation, before the contracting-out deduction was made.
The deduction was equivalent to the member's GMP. The contracted-out scheme was only required to increase the post-1988 GMP in line with prices up to a maximum of 3 per cent annually. The rest of the inflationary increase was effectively provided by the state - provided the GMP was less than the additional state pension and the individual was entitled to state pension increases. This arrangement shared the burden of the annual inflationary increase between the state and the public pension schemes.
This arrangement came to an end with the introduction of the single state pension. People reaching state pension age after 5 April 2016 no longer had have an additional state pension. This would have meant that such people could have lost full inflation protection of their GMPs, which would amount to a breach of the government’s commitments.
To meet its commitment to fully uprated GMPs in line with price inflation, the government had to find a solution. Its interim solution involved issuing orders which made the schemes responsible for full price indexation on the whole of the member's pension, including the GMP. This temporary solution initially applied to those reaching state pension age before 6 April 2018, before it was extended to 5 April 2021, while the government sought to alight upon a permanent solution to the issue.
In the government’s March 2021 response to its 2020 consultation, “GMP indexation consultation: Proposal to extend full indexation”, the government called GMP indexation the “most practical solution” to the issue. The government had previously raised conversion as an option, and had tasked the Government Actuary’s Department to establish a possible methodology for GMP conversion. The conversion method mooted was based on a £1:£1 conversion, with GMPs converted into a regular scheme pension, which would be fully indexed.
However, the government ruled out conversion as a permanent solution in its March 2021 response, saying that, “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 is likely to be resource intensive at a time when public service pension schemes do not have the capacity to undertake conversion until at least 2024.” By contrast, full indexation could of course be implemented by April 2021 since it was already in force on an interim basis.
In its March 2021 response, the government summarised the rationale for its decision that full GMP indexation was the preferable option. It said that the decision was reached in light of “capacity constraints” and “outstanding technical issues relating to conversion” as well as with regard to “legislative requirements; the diminishing numbers of members below SPa with a GMP” and the fact that “the majority of consultation respondents expressed a preference for the permanent extension of full indexation”.
The recent decision to make public service pension schemes permanently responsible for indexing GMPs provides clarity for pension schemes going forward, while also providing certainty to their members. While the changes primarily affect public sector pensions and the schemes of former state bodies, other schemes impacted include those which provide comparable schemes to comply with Fair Deal, where a public service was outsourced. Some members of such schemes will also benefit from the decision to protect the increases on GMPs, although the employer will have to bear any additional costs.
Some members with GMPs may be worse off in terms of their pension increases. However, the 2016 state pension reforms were complex and such losses could well be offset in other ways. For example, it may be possible for them to earn additional state pensions to replace the deduction they had from having had their pension contracted-out. After five years of rolling uncertainty, during which time interim solutions applied, at least the industry now has clarity as to the long term position. Such welcome certainty will enable the industry to plan for the future.
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