The Pension Protection Fund levy

When the Pension Protection Fund (PPF) raised the levy some final-salary pension schemes must pay in May, many employers were dismayed. The PPF set the scaling factor for the levy’s crucial risk-based element at 3.77 for 2008-09, more than 50% above the 2.47 applied the previous year. The scaling factor is the multiplier applied by the PPF to each contributing scheme’s levy, based on the risk each poses to the PPF, to meet the amount it has set to cover its long-term needs, this year set at £675m. The scaling factor has more than doubled from the PPF’s original estimate of 1.6 late last year.

This creates uncertainty. Schemes that are more than 140% funded are exempt from the risk-based levy, so it affects those with least room for manoeuvre. The big rise from the preliminary to the final figure makes it impossible for firms to estimate how much they will have to pay, which is particularly difficult for smaller employers. PPF chief executive Partha Dasgupta pinned the rise on the more detailed information on schemes’ financial strength received since the end of last year.

The picture may have worsened since May. The PPF’s index indicated schemes were running a total shortfall of £80.1bn at the end of July, up from £63.1bn a month earlier. Yet according to Lane, Clark and Peacock’s annual Accounting for pensions survey, employers have decreased the contributions they make to schemes, from £13.4bn to £13.1bn over the year.

Last year’s “”surplus”” lulled people into a false sense of security, says independent consultant Ros Altman. “”In reality, being in surplus on [accounting standard] IAS19 is a weak test and does not mean the scheme has enough money to pay all pensions in the longer term. There is scope to massage the numbers because of the lack of standardisation of discount and mortality rates used. This created a misleading picture of scheme health.””

The economic downturn is likely to escalate corporate insolvencies, swelling the number of schemes dependent on the PPF. But a rise in company failures will be problematic for it only if the calculations it has used for such factors are wildly out. Malin Makhecha, a consultant at Aon Consulting, says: “”The important question is whether the claims are greater or less than anticipated in the PPF’s long-term risk model, and whether they are greater than the level that can be absorbed without changing the levy parameters. In most cases, the levy is small relative to a scheme’s overall costs, and closing it doesn’t change the need to pay the levy or the amount of the payment.””

In many cases, the PPF levy is not a major factor in an employer’s decision to close a DB scheme to new entrants or to future benefits accrual. Gary Tansley, a consultant at actuaries HamishWilson, says: “”Uncertainty of cost due to external factors, such as economic and financial issues and increasing longevity, are the main drivers.””

The trend towards buy-outs could also affect future levies. Generally, it is the better-funded schemes with financially-sound employers that can afford the insurance premium, so the PPF could be left with the poorer-funded schemes. “”The PPF needed to make an addition of 0.19 for scheme closures and buyouts when amending its 2008-09 risk-based levy scaling factor from the provisional 1.6 to 3.77. So it could be concluded that if the trend continues, the PPF levy may gradually increase as there will be less schemes to charge a levy on,”” says Makhecha.

Tansley adds: “”The trend for buyouts may not be as bad as it sounds for the PPF as better-funded schemes with financially healthy employers currently contribute only a small proportion of the total levy raised. And, according to the PPF’s modelling, such schemes are currently not being charged enough to cover the longer-term risks they pose to the PPF.””

As the economic outlook worsens, actuaries are concerned that the Dun and Bradsheet failure score used to work out the multipliers underestimates schemes’ insolvency risk. The score was designed to focus on short-term cashflow rather than overall financial stability, which could create a false sense of security. Information clarifying D&B’s modelling strategy is expected in a consultation. The PPF may also try to create a framework for assessing risk-based levies that takes into account the risks posed by each scheme’s investment strategy

If you read nothing else, read this…

  • The scaling factor used by the Pension Protection Fund (PPF) to determine the risk-based levy payable by some final salary pension schemes for 2008-09 has doubled from the figure it initially suggested last November.
  • There are concerns that the levy could rise further as the economy stalls, reducing the number of schemes able to contribute at the very time demand on the PPF increases.
  • The trend for buyouts is being led by the best-funded schemes, causing fears the PPF will be left with a preponderance of the weakest, but these may be overplayed.