Pension Protection Fund

The Board of the Pension Protection Fund (the PPF) is a statutory fund in the United Kingdom and the British counterpart of the American Pension Benefit Guaranty Corporation. It was created under the Pensions Act 2004. The Board of the PPF is a statutory corporation responsible for managing the Fund and for making payments to members.

The PPF started on 6 April 2005 in response to public concern that when employers sponsoring defined benefit pension schemes became insolvent, scheme members could lose some or all of their pension if the scheme was underfunded. Besides offering compensation to those pension scheme members affected by insolvencies the Government hoped that the existence of the PPF would improve confidence in pension schemes generally.

The Board of the PPF has also taken over responsibility for managing the Fraud Compensation Fund, which will provide compensation to members of pension schemes who lose their entitlements due to Fraud. The PPF is chaired by Lady Barbara Judge.

Eligible Schemes

Most defined benefit schemes, as well as the defined benefit portion of hybrid pension schemes based in the United Kingdom are eligible for protection. The exceptions include schemes that are covered by a crown guarantee.

All eligible schemes are required to pay annual levies to the PPF to contribute towards administration and the compensation Fund itself.

Scheme Assessment

Before a scheme can enter the PPF it has to go through a period of assessment. Entry to the assessment period is triggered by a qualifying insolvency event. During assessment a valuation is carried out of the scheme's assets and liabilities. If this valuation finds that the scheme can afford to purchase annuities for members at or above the level of compensation the PPF would provide, then the scheme leaves the PPF assessment to wind up independently. If the scheme cannot afford to purchase such benefits for its members, the assets of the scheme transfer into the Fund and the Board takes over responsibility for paying compensation to members. This process is more complex if the company is a multinational company. In October 2011, the Court of Appeal ruled that Nortel Networks £2.1 billion pension debts should be considered as "administration expenses" rather than an unsecured creditor claim. US courts are likely to regard the claim as dating from the moment of underfunding rather than the administration date and hence the regulator is thought unlikely to be able to recover assets in the US.

Compensation

The PPF pays two levels of compensation:

• Any member who is over their normal retirement age or who retired early due to ill health will receive 100% of the pension they are currently receiving.

• Other members will receive the 90% level of compensation capped at a certain level. For the year from 1 April 2011, the cap is £33,219.36 per annum for members at age 65. From 2013, the cap will also increase by 3% for each year of service over 20 years.

The PPF also offers a dependent's pension of half the member's entitlement.

In the period prior to payment pension increases at the lower of 5% per annum compound and the increase in the Government's statutory inflation index (the Retail Price Index until January 2011, then the Consumer Price Index afterwards) across the period of deferred retirement. After retirement all pension relating to service after 5 April 1997 increases each year at 2.5% or the increase in the Government's statutory inflation index each year if lower; while all pension relating to service before 6 April 1997 will not increase.

Although the PPF is often billed as providing a guarantee to members' pensions, the amount of compensation is less than a member would have been entitled to under the rules of their original pension scheme. This is partly due to the compensation cap and 90% restriction on benefits but also because the indexation provided by the PPF may not be as generous as that otherwise provided by the scheme.

It is worth noting that the loss compared to what a pensioner would have received may be considerable. Easily as much as 50% over his predicated average life if most pension years were earned before 1997. As an example, a 50-year-old with a fully RPI protected pension before entering PPF of £4000 in today's money will lose over £100,000 over his expected life-span when that pension is converted into a PPF pension, assuming 2.5% CPI inflation. Considerably more to be lost if inflation goes over 5%.

Furthermore, if at some point in the future the PPF has insufficient funds to pay benefits then the level of benefits or increases can be restricted. However, the levels of compensation are set in primary legislation, so changing these levels would require an Act of Parliament to do so.

Levies

The PPF is funded by levies on all eligible defined benefit schemes.

In the first year of operation the PPF levy was a flat rate amount per member of the scheme.

After the first year of operation the levy is based on a scheme based element and a risk based element:

• 20% of the pension protection levy will be raised via the Scheme Levy.

• 80% of the pension protection levy will be raised via the risk-based levy. This levy depends on the level of underfunding in the scheme and the probability of the employer becoming insolvent over the following year. The probability of insolvency was estimated by Dun & Bradstreet until 31 March 2014, with Experian taking over this role from the end of October 2014. No insolvency risk data will be collected in the interim.

There is also an administration levy charged each year to provide for ongoing running costs. Together, the scheme-based levy and the risk-based levy make up the total PPF levy. The scheme-based levy is just proportional to the scheme’s PPF protected liabilities, where the long-term factor of proportionality is set to ensure that the scheme-based element comprises approximately 20 per cent of the pension fund levy. The PPF protected liability is the level of compensation that would be paid if the scheme were transferred to the PPF, it can either be the complete actuarial valuation according to section 179 of the Pensions Act 2004 or the adapted MFR (minimum funding requirement) liability, and normally it should be smaller than the ‘true’ pension liabilities given by FRS 17 or IAS 19 liabilities.

In order to calculate the risk-based levy the Board of the Pension Protection Fund considers the level of scheme underfunding (underfunding risk) and the likelihood of sponsoring employer insolvency (insolvency risk) and may also consider the asset allocation and any other risk factors that may be prescribed in regulations when setting the risk-based pension protection levy, which is reflected in the levy scaling factor the Board sets up and updates annually. The PPF assumed probability of insolvency is calculated in conjunction with a third party provider. From the 2006/07 to 2014/15 levy year, this was Dun & Bradstreet (D&B). From the 2015/16 levy year onwards this will be Experian.

The assumed probability of insolvency for the risk-based levy is calculated by identifying each participating scheme as being in one of ten risk bands related to the D&B or Experian insolvency risk rating as relevant (the more favourable the rating, the lower the band and the lower the insolvency risk used in the PPF levy calculation). Each risk band has an associated assumed probability of insolvency which is capped at 4%.

An eligible pension scheme covered by PPF can either be sponsored by a single employer (single-employer scheme) or more than one employer (multi-employer scheme) and many of the largest 500 pension schemes are multi-employer schemes with over 100,000 participating sponsoring employers between them. For a single-employer scheme the Board only needs to consider the risks underlying this individual employer when calculating the pension protection levy. However the risks faced by a multi-employer scheme may be different from those faced by single-employer schemes. The structure and the rules of different types of schemes have an impact on how the risk is shared among participating employers and therefore on the calculation of levy risk factors. Multi-employer schemes are classified into several categories according to the Pension Protection Fund (Multi-employer Schemes) (Modification) Regulations 2005 (or the Pension Protection Fund (Multi-employer Schemes) (Modification) Regulations (Northern Ireland) 2005) depending on whether the employers in the scheme are from the same or similar sectors (sectionalised/non sectionalised) and whether the scheme has an option or requirement to segregate upon cessation of a participating employer.

For schemes with neither a requirement nor discretion to segregate on cessation of participation of an employer a ‘last-man-standing (LMS)’ pension protection levy applies, under which the Board will not trigger an ‘assessment period’ until the last employer in that scheme becomes insolvent. For multi-employer sections/schemes with an option or requirement to segregate on cessation of participation, the scheme pays a ‘segmented’ levy, which means each sponsoring employer is only responsible for its own pension liabilities and in the event of insolvency, only the insolvent firm’s pension liabilities are transferred to the PPF, not the whole scheme.

For both LMS and segmented multi-employer schemes the insolvency risk is calculated as the weighted average probability of insolvency for all participating sponsoring employers, but in the case of an LMS arrangement, these probabilities are adjusted by a scaling factor (< 1) to reflect the degree of correlation across the employers in the scheme. The PPF defines an associated pension scheme as one that has more than one sponsoring employer and where the sponsoring employers are financially dependent or linked to the same parent company. For associated schemes the scaling factor was 0.9 up to the 2014/15 levy year (the factor going forwards is still to be confirmed by the PPF) whilst for non-associated schemes the scaling factor is the ratio between members of the largest employer and the total number of members for the entire scheme.

Hence, the scaling factor ensures that the last-man-standing risk-based levy is lower, but raises a cross-subsidy issue, since an insolvent participating employer will be funded by the rest of the employers in the set of multi-employers. The Universities Superanuation Scheme (USS) is an example of a multi-employer scheme covering 391 universities and related institutions. Liu and Tonks (2009) assess whether levy payments made by USS reflect the underlying risks of the participating institutions.

2005/6

In the PPF's first year it intended to raise £150m. However, the actual levy raised was about £138m.

2006/7

For the year from 6 April 2006 the PPF intend to raise £575,000,000 via the pension protection levy. The scheme levy was set as 0.014% of the Scheme's liabilities.

The total PPF levy for 2006/7 was capped at 0.5% of the scheme's liabilities measured using the PPF's basis.

In the year from 6 April 2006 the administration levy is estimated to collect £15,000,000

2007/8

For the 2007/2008 year the PPF intend to raise £675,000,000, compared to the £575,000,000 raised in 2006/2007. The cap has been reduced to 0.75% of the scheme's liabilities on a Section 179 basis.

See also

• Pension Benefit Guaranty Corporation - The equivalent body in the United States

External links

• Official website
• Association of Member-Directed Pension Schemes (AMPS) - The principal body for discussing changes involved in the area of pension planning.