Of interest to all schemes providing defined benefits, is the Pension Protection Fund’s (PPF's) publication of several draft documents for consultation, including its proposed new levy determination and contingent asset guidance. The PPF has confirmed that the levy estimate for 2015/16 will be set at £635 million, which is almost 10 per cent lower than the 2014/15 estimate. Consequently, the majority of schemes will see a reduction in their risk-based PPF levy.

The deadlines for submission of scheme information have also been confirmed and affected schemes should take the opportunity to diarise these. The new draft levy determination is expected to be finalised in December 2014.

We will be looking in detail at the new risk-based levy scoring process and other PPF issues for schemes in one of our upcoming client briefings.

Background

In May 2014, the PPF published for consultation the outline of its proposed new regime for calculating the risk-based levy, following the appointment of Experian to replace Dun & Bradstreet as its insolvency risk score provider. A new “PPF-specific” risk scoring system was introduced, based on a system of “scorecards” to segment employers.

The consultation on the new Experian model, which was developed solely using information on employers sponsoring defined benefit (DB) schemes, noted that the total change in levy would be an overall reduction of approximately £200 million. While the majority of schemes would see a reduced levy, over 600 would see their levy rise. A separate scorecard has been developed for not-for-profit organisations.

Documentation for the new risk-based levy scoring process

On 6 October 2014, the PPF published the following documents:

The policy statement confirms the results of the May 2014 consultation and the draft Determination sets out the proposed practical application of the new policy in calculating the risk-based and scheme-based levies.

The policy statement also sets out the levy structure for the three years 2015/16 – 2017/18 and confirms that the PPF-specific risk model outlined in the consultation will apply for those three levy years, starting from 31 October 2014;

  • draft guidance is also available for each class of contingent asset; and
  • draft updated standard form contingent asset documentation is also available, although the final versions of the forms will not be published until December 2014. Schemes wishing to enter into a contingent asset agreement before then should use the existing forms.

The new levy-scoring process

The policy statement provides detail of what the PPF-specific risk model for calculating levy scores will involve:

  • Averaging of insolvency probabilities. Employer insolvency probabilities will continue to be averaged over 12 months. However, scores will be collected for use in the 2015/16 levy only from 31 October 2014, with a six month average used in the levy calculation. For future levy years, starting from 2015, the average month-end scores over the 12 months from 31 March will be used;
  • Segments. Organisations will be placed in one of eight different segments based on the availability of financial information for each of these groups. The information contributes towards the production of a “scorecard” to predict an organisation's likelihood of failure. The model is based on financial information from a range of sources including Companies House, the Charity Commission, and Experian's trade payment system;
  • Scorecard arbitrage. The PPF will take steps to prevent “scorecard arbitrage”, by which it means organisations attempting to change their allocated scorecard by producing consolidated accounts or making corporate changes. The PPF considers that the “large and complex” scorecard is most at risk of manipulation. As a result it has altered the entry conditions to exclude companies that file consolidated accounts but do not meet any of the other criteria (for example, being an ultimate parent).
  • Bands and rates. The policy of allocating a levy rate to different insolvency bands will continue. Scheme employers will fall in one of ten levy bands, according to their insolvency-risk probability. The first band contains the lowest 20 per cent of risks, descending to the last two bands that contain 5 per cent each. Minor changes have been made to the bands and the risk probabilities since the last consultation.
  • Not-for-profit (NFP) organisations. These will be assessed using a single separate scorecard. Employers on the scorecard will be scored using Experian’s insolvency risk data from both within and outside of the PPF-employer universe. This contrasts with the previous Dun & Bradstreet method which automatically allocated NFPs to the lowest risk band.
  • Last-man standing schemes. The last-man standing discount will continue to apply. However, a larger discount will apply to schemes with more participating employers and where the allocation of members between those employers is more even. For levy year 2015/16, TPR will write to all schemes identifying themselves as last-man standing schemes on Exchange to ask them to confirm that they have taken legal advice that supports that conclusion. Only schemes that have supplied the appropriate confirmation by 31 May 2015 will benefit from the discount. The changes reflect that such schemes have more than 80 per cent of their members located in only one employer.
  • Type A contingent assets. Trustees will be required to certify contingent assets with a fixed value, known as the “realisable recovery”, which they are confident the guarantor can pay if required. The trustee certification has been changed to reflect this.
  • No transitional protection. This proposal in the consultation for transitional protection has been dropped. The majority of respondents were not in favour of it, with the PPF stating that respondents expressed the view that they no longer wished to cross-subsidise those who, it now turned out, were worse risks than previously thought.
  • No credit-rating override. Similarly, this will not be taken forward as the majority of stakeholders' responses were not in favour of its use.

Consultation issues

The PPF is seeking views on two significant areas in the draft levy rules: asset-backed contributions (ABCs) and mortgage age. Consultation on these two issues forms part of the broader consultation on the new draft rules and runs until 13 November 2014.

ABCs

The PPF's previous proposals to change the treatment of ABCs for levy purposes were criticised by several respondents, particularly regarding the proposed limiting of recognition to UK property-based ABCs. The PPF's revised proposal is that:

  • there will be no restriction on the type of underlying asset that can be used, “provided the ABC is valued in a way that reflects the value to the PPF in the event of insolvency”;
  • the PPF expect trustees to certify the lower of
  • the insolvency value of the interest in the special purpose vehicle; and
    • the fair value reported in the most recent scheme accounts.
    • The lower of the two values will be used in the risk-based levy calculation. Trustees will also have to confirm the fair value as at the section 179 valuation date;
  • the asset will need to be valued by “an appropriate professional” on an insolvency basis, meeting certain basic requirements prescribed by the PPF and “prepared on a basis on which the trustee and the PPF can rely”.

This will need to be supported by a legal opinion on the contractual arrangements that attach to the asset, and the trustees' rights under those contracts. The report produced (and any advice which has fed into it) must state explicitly that the valuation “can be relied upon by the Board for levy calculation purposes”. The PPF considers that this will create a duty of care to the PPF.

Draft guidance on ABCs has been produced along with a sample ABC certificate.

Mortgage age

The variable in the Experian model which received the most comments in the consultation was that based on the age of the most recently secured charge, referred to as the “mortgage age” test. The PPF states that Experian's analysis showed this to be a highly predictive variable, illustrated by the fact that companies without a charge have around a third of the failure rate of companies with a charge. New charges represent a particular risk.

Although the variable will be retained, the PPF is consulting on whether certain mortgages will be regarded as material for the purposes of the model, and what evidence should be adduced to show this. The PPF proposes to exclude from consideration certain charges that are less likely to be reflective of heightened risk, such as rent deposit deeds and charges in favour of the pension scheme. The consultation proposes a number of situations where mortgage charges should not be taken into account in the risk-based levy calculation.

The PPF proposes two methods to assess materiality:

  • a test comparing the size of the charge with the resources of the business. The PPF proposes to set a threshold of 0.5 per cent of total assets as shown in the chargor's latest filed accounts. Where there is more than one mortgage, the consultation proposes that it should be possible to certify more than one mortgage as immaterial provided that, collectively they are within the materiality threshold of 0.5 per cent of total assets. However, each charge that an employer wishes to exclude would need to be identified and considered individually; and
  • a test focused on access to capital markets through an investment grade credit rating.

Employers will be able self-report and inform the PPF of relevant charges at any time between the end of December 2014 (when it is likely the new proposals will be finalised) and 31 March 2015.

Issues for schemes and information deadlines

The PPF has improved the web facility by which schemes can track their score. This will enable them to engage with Experian to understand their score, before the scores are used from 31 October 2014. The majority of the levy management tools which were available under the “old” system continue to apply. Any scheme wishing to use a contingent asset between now and December 2014 should use the existing version of the relevant contingent asset form.

The PPF recognises that the move to Experian, and the change in employer and guarantor levy rates, may negate the levy advantage for certain contingent assets, potentially leading to a reduction in the number of recertifications for 2015/16. In addition, the proposed strengthening of the Type A contingent asset wording could also give rise to reduction in recertifications (similar to the position in 2012/13, when the current wording was introduced).

The PPF is considering a possible extension to the type C contingent asset class to include surety bonds. Currently, this class is limited to letters of credit or bank guarantees. The PPF state that it possible that such a new asset class could be included within the current type C(ii) contingent asset documentation, which it could modify.

The PPF has confirmed the dates by which relevant information should be submitted:

Click here to view table.

Invoicing being in Autumn 2015.

Comment

Schemes should check as soon as possible that their Experian score is what they expected, using the PPF's new online system. Changes related to the new model, together with updated data obtained by, or provided to Experian, may have resulted in changes in scores for some employers. The changes have been included in information available on the portal when it re-launched on 7 October 2014.

The PPF has confirmed that over 75 per cent of schemes have accessed their score information so far. In addition, scores may change as schemes and employers provide new data. Schemes and employers can elect to receive updates automatically from Experian when their score changes. Where there is an area of concern, addressing this earlier in the process is a much easier option than contesting a levy invoice once it has been issued.

The overall impact of the changes appears to have been positive, and is reflected in a reduced levy estimate. However, although some schemes will benefit from this new structure, those who will see an increase in their levy bill could be significantly worse off with some 600 schemes seeing an increase of over £50,000. In that event, it is essential that those schemes access their scheme data as soon as possible and take advice on whether action could be taken to improve their score.

As always, schemes wishing to certify, or re-certify, contingent assets should start the ball rolling as soon as possible, so as to avoid a last minute rush to meet the relevant deadlines.