Trustees and employers can take steps to reduce the levy imposed by the Pension Protection Scheme.
The purpose of the Pension Protection Fund (PPF) is to pay compensation to members of certain defined benefit pension schemes whose employers become insolvent and where there are insufficient assets in the scheme to pay PPF levels of compensation.
The PPF is funded in part by the pension protection levy, which is split into two sub-levies: the “scheme-based levy”, which represents 20 per cent of the amount schemes must pay in total; and the “risk-based levy”, which represents 80 per cent of schemes’ levy liability. Two key elements of the calculation of the risk-based part of the levy are as follows:
- The amount of the scheme’s underfunding (on a PPF, or Section 179, funding basis). Broadly, the PPF deficit is the difference between the value of the scheme assets and the cost of providing the PPF level of benefits. Every defined benefit pension scheme should have completed a Section 179 valuation by 31 March 2008.
- The risk of the insolvency of the employer(s) sponsoring or participating in the scheme. Dun & Bradstreet has been appointed by the PPF to assess the risk of the insolvency of each employer sponsoring or participating in a relevant scheme. It produces its risk assessment on a sliding scale of 1 to 100. For multi-employer schemes, a weighted average of the risk of insolvency, or “failure score”, of all the employers is used in the calculation of the risk-based levy.
Measures can be taken to reduce the “risk-based levy”.
Differences from 2007-2008
Any savings made by taking one of the courses of action below may have a long-term benefit, as schemes’ 2009-2010 levy liability will be based on key elements of scheme and company data provided as of 31 March 2008.
The PPF has changed some of the elements taken into account in calculating a scheme’s levy liability. These changes have been designed to increase stability in the year-on-year levy liability but will inevitably result in some “winners” and some “losers” unless some action is taken to mitigate the effect of the changes.
- The funding limit at which schemes receive a reduction to the risk-based levy has increased from 104 per cent to 120 per cent.
- The funding limit at which schemes do not pay the risk-based levy has increased from 125 per cent to 140 per cent.
- The cap to the amount of the risk-based levy that schemes pay has reduced to 1 per cent of their liabilities from the current 1.25 per cent.
The primary liability to meet the pension protection levy lies with the scheme trustees. Ultimately, however, the cost will be met by the employer as a result of the nature of defined benefit pension scheme funding. Usually this cost will be met through an increase in ongoing contributions negotiated with the scheme trustees.
Levy Reduction Measures
The PPF aims to collect £675 million under the pension protection levy in 2008-2009, but trustees (and employers) may be able to reduce their bill if they act now. The PPF itself has set out limited guidance on levy reduction measures, which is included in the summary below.
- Employers may make a “deficit reduction contribution” (over and above the normal ongoing contribution payable under the schedule of contributions) to improve the scheme’s PPF funding level.
- Employers may put in place contingent asset arrangements, e.g., a parent or group company guarantee in favour of the scheme. If a guarantee of at least 105 per cent funding on a PPF valuation basis is in place, it will result in a “risk switch”, so that the guarantor’s insolvency risk is substituted for the employer’s. Providing security over employer or other group company assets, or providing a letter of credit or bank guarantee, will ensure that the value of the contingent asset will be taken into account in determining the level of the scheme’s funding on a PPF basis.
- Where a contingent asset arrangement, which is not in the PPF’s standard form for such arrangements, is already in place, it must be replaced with the PPF standard form documentation if credit is to be received for it in calculating the risk-based levy for 2008-2009 and subsequent years. Where a contingent asset arrangement on standard form PPF documentation has already been put in place and recognised for the purpose of the 2007-2008 levy, it must nonetheless be re-certified as meeting the relevant criteria for the purposes of the 2008-2009 risk-based levy calculation.
- Employers and trustees should ensure that all data provided to the PPF is correct at the time of submission. Unlike 2007-2008 and previous “levy years” where corrections to data were allowed up until receipt of the levy invoice, no corrections or supplementary information will be accepted by the PPF for the purposes of the risk-based levy calculated after 31 March 2008, except notification of a deficit reduction contribution made since the last Section 179 valuation, which must be made by 7 April 2008.
- Employers should ensure that Dun & Bradstreet are provided with any relevant information which may improve the employer’s “failure score”, e.g., any recent or impending corporate activity, such as legal reorganisation or mergers and acquisitions activity.
- Employers should engage with Dun & Bradstreet to determine whether there are any cost efficient measures the employer could take to improve its “failure score”.
- Employers should ensure that details of any contingent asset arrangements are provided to (or re-certified, if appropriate) the PPF by 31 March 2008, and ensure that any deficit reduction contributions made since the date of the Section 179 valuation are notified to the PPF by 7 April 2008.