Calculating the Pension Protection Fund levy

The levy into the Pension Protection Fund’s compensation pot is as likely to rise as to fall, so future risk-based fees are causing concern, says Debbie Lovewell

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The Pension Protection Fund (PPF) levy is set at a flat rate for the first year, but will then be calculated on the judged risk of a scheme.

Some organisations are looking to make one-off contributions to their scheme in order to reduce future costs.

Employers will also be liable for a further levy to pay towards the running costs of the PPF.

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When the Pension Protection Fund (PPF) was established earlier this year, employers offering a defined benefit (DB) pension scheme experienced one of the first incoming changes under the much awaited Finance Act 2004. One element, which is not likely to be popular with everyone, is the introduction of levies to fund the PPF’s compensation pot.

For the first year, this levy is set at a flat fee of £15 for pensioners and active scheme members, and £5 for deferred members. From next year, however, the amount employers will have to pay will depend on how risky their scheme is judged to be. This decision will be based on a number of factors including the possible riskiness of a scheme’s investment strategy, the likelihood of an employer becoming insolvent and how far a scheme is underfunded. But while the levy is intended to protect employees’ pension benefits, what will these additional costs mean for employers?

Steve Bee, head of pensions strategy at Scottish Life, explains that a lack of definitive information about the levy means employers face some uncertainty: "We don’t know what the level of the risk-based levy is likely to be. There was some indication that it wouldn’t be more than the flat rate but I don’t know where that is now. Clearly, if you find that the way you structure your scheme means you’ll be paying much more than any other company into the risk-based levy, then I suppose the writing is on the wall."

So with the levy equally likely to rise as to fall, some organisations are looking to pay in additional funds to their pension scheme to potentially cut future costs. A number of large organisations, such as Marks & Spencer, have already made significant one-off contributions to reduce their schemes’ deficits. Roger Cobley, president of the Pensions Management Institute, however, warns that organisations should weigh up the pros and cons of doing so: "The employer must consider what they want to do with limited financial resources and whether putting it into the pension fund to reduce the cost of the levy compensates for losing it elsewhere."

For employers that are financially unable to do so, all is not lost. Bee believes that some of the additional costs could be passed on to pension scheme members, but acknowledges this is not necessarily a long-term solution. "From an employer’s point of view, this is an insurance premium that is being paid to protect members’ benefits. Now an employer wouldn’t pay [employees’] car insurance or house insurance so why should they pay their pension insurance? I think there’s a strong argument [for passing this onto employees] for the flat rate part of the levy. Whether that extends to the risk-based levy where the individual wouldn’t have any control over the way the company is structured, then probably not."

But whether this is a viable solution remains a matter of debate. After all, if staff are paying more, they may well expect their employer to do the same. In addition, many organisations have downsized in recent years, so now have a higher number of pensioners than active members. "For those employers continuing with DB schemes, the additional cost of the levy may be the final straw that causes them to close the scheme to new members," warns Cobley.

And taking steps to cut future levy costs may also increase employee confidence in a scheme and therefore their employer. Cobley adds: "In time, it may be possible for members of schemes to obtain an indication of the risk as assessed by the PPF as to the security of their own benefits."