Finance Directors' Guide to Pensions
The Pension Protection Fund
It was established by the Pensions Act 2004 and is independent from the UK Government. Detailed information on the PPF and the calculation of the levy can be found on The PPF Levy Forum.
Some compensation for members of schemes that are ineligible for the PPF was provided through the UK Government's Financial Assistance Scheme (FAS), which is financed by UK taxpayers. However, the PPF is funded through a number of levies, which are payable by all sponsors of eligible defined benefit pension schemes, together with the assets of schemes that fall into the PPF, any recoveries it can make from insolvent employers and investment returns made on these assets.
The Pension Protection levy is effectively an insurance premium, whereby any employer that sponsors an eligible defined benefit pension scheme must contribute towards the funding of the PPF. Whilst the levies can be payable from scheme assets the employers will ultimately pick up these costs. More detail on the levies payable is covered in the PPF Levy section below.
The level of compensation payable to members in the PPF is the following:
Executives and high earners, who have benefit levels well above the cap but who have not yet reached their normal retirement date, and members with very generous pension increases, could face a material reduction in the value of their future benefits if their pension scheme enters the PPF.
* the 'compensation cap' is prescribed by the PPF each year and is dependent on a member's age. The cap for the year starting April 2016 equated to £33,678.38 at age 65 (after the 90% has been applied). Future legislation is expected to increase the cap for members with service over 20 years.
Eligible pension schemes are required to carry out Section 179 valuations (as set out in Section 179 of the Pensions Act 2004) every three years as part of their formal actuarial valuation process. This type of valuation is similar to the approach required for a Section 143 valuation in that it determines the ability of a scheme to provide benefits at least at the level of PPF compensation. The difference is that Section 179 valuations were intended to be simpler, and therefore less time consuming, compared to Section 143 valuations. The PPF prescribes the assumptions and publishes guidance on this area.
The results of the Section 179 valuation are used by the PPF to determine the aggregate level of Section 179 underfunding across all eligible pension schemes in the UK. This is then used to construct the framework under which all schemes' pension protection levies are determined. The results of individual schemes' Section 179 valuations are used to calculate their main Pension Protection levy.
The Pensions Regulator (TPR) also uses the results of a scheme's Section 179 valuation to consider the risk posed by a scheme to the PPF. Please see the Scheme Funding section for more information on how TPR regulates defined benefit schemes.
Each year the PPF raises funds by imposing levies on eligible pension schemes. These levies include the Administration levy (which pays for the ongoing administrative costs of the PPF), Fraud Compensation Levy and PPF Ombudsman Levy when required. However the most significant levy is the Pension Protection levy - this is composed of the following two parts:
There are a number of ways in which employers can make sure the levy amount reflects the true risk posed by their scheme, so that they are not paying more than their fair share. One way in which employers have been providing additional security to schemes has been to put in place a contingent asset.
The levies are calculated by the PPF using information disclosed in the annual Scheme Returns which are submitted to the Pensions Regulator. Any additional voluntary certificates submitted to the PPF (i.e. deficit contribution certificates, contingent asset certificates and mortgage certificates) are also taken into account.
For further information on the PPF levies, visit The Levy Forum.
The Experian model comprises eight different scorecards. Companies are allocated to these scorecards based on their particular characteristics, for example turnover, whether or not the company is part of a group, and the type of accounts filed. There is also a separate scorecard for not-for-profit companies.
Within each scorecard, the Experian model uses several different metrics to assess the insolvency risk of a company. These metrics, which mostly use information obtained from company accounts, have been derived based on a statistical analysis of historical insolvency events. The PPF generally use the insolvency risk associated with the employers participating in a scheme to calculate the levy. However, in certain circumstances the insolvency risk of another company in the group (for example a parent company) can be used. For example, this may occur if a "PPF guarantee" is put in place for a sufficiently strong company. The legal and financial implications of putting in place such a guarantee would need to be considered since the guarantor would be responsible for paying the benefits of members employed by a participating employer on insolvency.
Broadly speaking, in order for a pension scheme to be eligible to receive compensation from the PPF, it must satisfy the following conditions:
Occasionally, the PPF are prepared to strike a "compromise deal" with a pension scheme sponsor in order to avoid insolvency, however for this to be feasible there needs to be a definitive threat that if such a deal is not agreed then insolvency will be unavoidable. The PPF is usually offered an equity share in the company in exchange for agreeing to take on the pension scheme.
The size of the share offered to the PPF will vary depending on circumstances; typically we would expect a 10% share to be accepted in restructuring cases where the existing shareholders do not participate in the restructuring. However, where they do participate, a larger share would be likely to be required; we would expect this to be between 30% - 35%.
These agreements are relatively rare and there have only been a handful of cases so far. One of the most famous cases is with Ennstone plc. The PPF agreed to take on the defined benefit pension scheme in exchange for an immediate cash contribution and a 10% share in the restructured company.
However, compromise deals are not always accepted; probably the most well-known case where the Regulator declined such a deal is with the Readers Digest. Silentnight is another example of where a compromise deal has been rejected.
Under US GAAP, this is calculated as the difference between the expected return on the assets over the accounting period less the interest on liabilities This calculation makes allowance for cashflows in and out of the scheme over the period.
The calculation is similar under FRS102 and IAS19 except that the expected return on assets is effectively set to be equal to the discount rate.
There is still an option under US GAAP for a smoothed market value to be used in this calculation.
The next stage is for the PPF to contact the trustees of the scheme and obtain the information it requires in order to carry out an assessment as to whether or not the scheme should pass into the PPF 'assessment period'. The PPF then make a decision within 28 days and validates the Section 120 notice if appropriate. At this point, the scheme is deemed to have commenced the assessment period.
During the assessment period the PPF ensures that all data held by the scheme is accurate. The trustees are also responsible for informing members of the progress the scheme is making throughout the assessment period and also for continuing to pay members' benefits. The level at which these benefits are paid must be equivalent to the PPF levels of compensation.
The scheme's actuary will also carry out a Section 143 valuation of the scheme (as set out in Section 143 of the Pensions Act 2004). The assumptions used for this valuation are prescribed by the PPF and guidance is published by the PPF on S143 valuations. If the results of the Section 143 valuation indicate that the scheme can purchase benefits at or above the PPF levels in the open market, then the scheme's members will not be provided with compensation from the PPF. The PPF may make a funding determination instead of requiring a full S143 valuation if it is clear that the PPF level of benefits will be significantly underfunded or significantly overfunded.The following graph, taken from the TPR and PPF's 2015 Purple Book, shows the distribution of schemes by industry classification that are in assessment and are eligible for PPF compensation.