Earlier this year, the Pension Protection Fund (PPF) published its consultation on the second PPF Levy Triennium (2015/16 to 2017/18) which proposed wholesale changes to the measure of insolvency risk and significant changes in respect of contingent assets and the PPF’s treatment of asset-backed contributions.
As we await the outcome of the consultation, employers and trustees may find a summary of the proposals helpful in trying to gauge how they could impact their scheme’s PPF levy.
The PPF-specific insolvency risk model
The PPF has developed a new insolvency risk model with Experian, its newly appointed provider of employer insolvency information. To create the model, they focussed on the composition of employers in the ‘PPF universe’ rather than UK employers as a whole. It is expected, therefore, that the model will be able to predict more accurately the insolvency risk of employers with eligible defined benefit schemes.
The key differences between the previous approach taken by Dun & Bradstreet and the new PPF specific model are:
- the PPF specific model focusses on financial data such as balance sheet information whereas previously greater emphasis was placed on non-financial elements (such as location and number of directors);
- each employer will be assessed by reference to one of eight scorecards, depending on the size and/or nature of the business, and each scorecard will assess insolvency risk by reference to its own set of criteria;
- a not-for-profit scorecard has been proposed to deal with charities and other not-for-profit organisations; and
- there is greater weighting of parent strength where an employer is part of a group structure.
The PPF has also suggested introducing a credit-rating override whereby, if a credit rating is available in respect of an employer, the credit rating would be converted to a PPF insolvency score. However, this proposal has been seen by some as an unnecessary complication to the system with little foreseeable benefit.
Employers are currently placed in bands depending on their insolvency risk. The PPF proposes to keep the number of insolvency bands at 10 but to change the groupings so that 20% of employers are in band 1 (the least risk of insolvency), 10% of employers are in each of bands 2 to 8 and 5% of employers are in each of bands 9 and 10. Arguments for alternative bandings, such as an 8 band system with 40% of employers within band 1, will also be considered.
The PPF has created a portal, which can be accessed by trustees and their advisers, to allow trustees to view the information currently held in respect of their scheme and the scheme’s employers. Access to the portal has already been given to schemes so that scheme data can be verified and any issues addressed prior to 31 October 2014. This is because the intention is to use the monthly scores from 31 October 2014 to 31 March 2015 for the 2015/16 levy year, but to revert to twelve monthly scores thereafter.
Winners and losers
The PPF-specific insolvency risk model is not designed with a view to increasing the overall amount of levy collected. There will, however, be winners and losers.
Those employers who would have scored badly in respect of the non-financial elements under the old Dun & Bradstreet system but who have strong financials under the new model and those with a parent with a strong insolvency score would be likely to see an improvement in their insolvency score. In contrast, those who would have scored well in respect of non-financial elements but are weak on financial elements or those with a weak parent would be likely to see their insolvency score fall.
PPF figures indicate that more schemes will see a fall in their levy rather than an increase. For those schemes which will see a significant increase, transitional protections are proposed. A number of different transitional protection methods are being considered but it is likely that any transitional protection would be funded by way of cross-subsidy from all schemes.
The use of asset-backed contributions (ABCs) as a risk reduction measure has been on the increase over recent years. The PPF has, therefore, determined to put in place specific provisions regarding how ABCs are valued and recognised.
The PPF’s suggested approach to ABCs appears to err on the side of caution. The key features of the proposals are to:
- remove the value attributed to ABCs in scheme accounts from the section 179 asset valuation;
- require annual certification of ABCs, if the scheme wishes to receive credit for the ABC as a risk-reduction measure, with the value of the ABC to be based on the lower of:
- the value of the underlying asset in the event of employer insolvency, and
- the net present value of future cashflows; and
- recognise ABCs only where the underlying asset is cash, UK property or securities.
Given the diverse nature of the assets underlying ABCs it is anticipated that there will be objections in respect of the restrictive nature of the current ABC proposals. Schemes with ABCs (especially those with ABCs which would not be recognised by the PPF under the current proposals) should ensure that they become familiar with the PPF’s final position and any implications for their scheme.
Type A contingent assets – company guarantees
The PPF’s experience is that the amount recovered through company guarantees following insolvency of a PPF employer is minimal when compared with the amount guaranteed and testing of contingent assets has resulted in a high number of rejections in recent years. The PPF has considered removing recognition of Type A contingent assets but it states that this “would represent a significant departure from our policy of recognising risk-reduction measures, and would result in higher levies for those stakeholders with a viable commitment from the guarantor”.
So, instead, the PPF has proposed that trustees should certify contingent assets on the basis of a specific cash sum (rather than a funding amount) which the trustees believe the guarantor can provide in the event of the insolvency of the scheme employer. Alternative trustee certification wording is also suggested in which the trustees would be required to make “reasonable enquiry into the financial position of each certified guarantor” and “are reasonably satisfied that each certified guarantor …, could meet in full [the amount certified] , having taken account of the likely impact of the immediate insolvency of all the relevant employers.”
Depending on the final wording of the trustee certification, trustees may decide that they need to obtain additional advice and information before providing certification of a Type A contingent asset for future levy years.
The PPF also proposes to make adjustments to the score of a guarantor to reflect the additional potential liability under the Type A contingent asset. In some instances this could erode the positive impact of entering into the Type A contingent asset.
Last man standing schemes
Broadly, a “last man standing” scheme is a multi-employer scheme under which there is no option to segregate on the insolvency of one of the employers, meaning all employers must fail before there can be a claim on the PPF. Currently, last man standing schemes receive a 10% discount on their levy to reflect the perceived reduction in risk to the PPF.
The PPF is of the view that a significant number of schemes have misreported their scheme structure and is therefore considering introducing a requirement for trustees to certify that legal advice has been taken on the scheme structure claimed.
In addition, the PPF is proposing to change the current position so that the 10% reduction afforded to last man standing schemes becomes a reduction of up to 10% depending on the dispersal of members between scheme employers.
What should trustees and employers be doing?
Scheme trustees and employers should ensure that they review the data held on the PPF portal as soon as possible to ensure that the information is accurate and up to date. Where changes are required, steps should be taken to ensure records are accurate prior to 31 October 2014, when employer data will start being used to measure insolvency risk.
Once the outcome of the consultation is known:
- last man standing schemes and schemes which have in place Type A contingent assets or ABCs should consider the implications of the new rules; and
- last man standing schemes should also consider whether legal advice is required in respect of the scheme’s structure.