PPFSM - will you win or lose?

Published by Simon Taylor on

The Pension Protection Fund (PPF) has today published a consultation setting out its plans for the next three levy years. This consultation confirms the PPF’s intention to use a bespoke insolvency risk model for the purposes of calculating future PPF levies, replacing the Dun & Bradstreet (D&B) model that has been used since the inception of the PPF.

The bespoke insolvency risk model, known as the PPF-specific model (PPFSM), has been developed in partnership with Experian and, unlike the commercial D&B model, is based only on companies that sponsor PPF-eligible pension schemes.

"Companies should ensure that they understand their insolvency risk score under the new model and the impact it will have on their levy. It is equally important that the data held on Exchange and the data used to calculate their score is checked for accuracy and stays up-to-date. "

In a similar manner to the D&B model, a company’s insolvency risk will be assessed via the use of a scorecard system.  However, three primary factors, namely company turnover, corporate structure and the type of accounts filed, will be used to allocate entities between scorecards.  In total, a range of seven distinct scorecards will be created in this manner, with a further eighth scorecard also being established for Not-for-Profit entities.  While a larger suite of scorecards provides for a more tailored risk-measurement solution, it will in itself also introduce an element of volatility for a minority of companies that move between the different scorecards. 

Under the PPFSM each scorecard comprises of up to seven different variables.  These variables (which differ between scorecard in both measure and weighting) are driven predominantly by the latest Balance Sheet and Profit and Loss entries from a company’s financial statements.

The main difference between PPFSM’s and D&B’s model is a greater emphasis on financial indicators (such as scale of operations and profitability).  The shift away from non-financial measures (such as the number of Directors and Geographical Location) could drive some quite stark changes in the PPF’s measure of any individual sponsor’s insolvency risk.   Another major change is the inclusion of the strength of the group as a whole in the score of an individual company.

The PPFSM’s emphasis on financials will also mean that the manipulation of insolvency ratings is far less feasible than it perhaps was under the D&B model, where, for example, increasing the number of registered Directors might have resulted in an improved failure score. From the perspective of both the PPF and the levy payer, placing greater emphasis on financial indicators should make the estimation of the overall annual levy amount more predictable.

Overall, we believe that these changes are a positive move by the PPF.  In particular, the model will direct the focus specifically on the risks posed by the sponsors of defined benefit schemes, and will be expected to reduce the volatility in individual scores over time. Experian’s free-to-access web platform will allow companies and trustees to see exactly what information is being used to calculate and drive their score, as well as providing them with the ability to understand and manage those changes in their individual circumstances that will directly impact their levy.

At an individual company level, however, the change will inevitably result in some substantial differences arising in an individual company’s insolvency risk rating under the respective models.  While any movement has the potential to drive significant changes in future levy invoices, in many cases, this change will result in a levy that better reflects the risk posed by schemes to the PPF.  However, there will undoubtedly be cases where it does not. Companies should ensure that they understand their insolvency risk score under the new model and the impact it will have on their levy.  It is equally important that the data held on Exchange and the data used to calculate their score is checked for accuracy and stays up-to-date. 

The consultation will also consider, amongst other things, whether an eight- or ten-band risk-rating system is appropriate for converting scores into insolvency probabilities going forwards, as well as the corresponding levy rates for each band.

As part of the wider review for the levy Triennium, the PPF has also put forward a number of significant proposed changes to the way in which levies are calculated for schemes with Asset Backed Contributions and Type A Contingent Assets (i.e. unsecured guarantees), as well as those of a Last Man Standing scheme structure. These proposals are designed to ensure the levy better reflects the risk posed by schemes affected by these issues. While the impact of the proposed changes will only affect a subset of the schemes within the PPF risk universe, there may be material implications for levies payable by these schemes.

The consultation closes on 9 July 2014, and can be found here.