How can trustees ensure that the levy accurately reflects the risks thier fund poses to the PPF?
Nobody likes paying bills and the Pension Protection Fund (PPF) levy is a contentious subject for some schemes.
The lifeboat fund plays a vital role in compensating members of underfunded schemes after their employers have gone bust. But the levy that funds it can be a relatively large cost for employers, and most trustees expect – or hope – never to have to use the PPF’s services.
And, as this money could otherwise be used to grow the company’s business, or cut the scheme’s deficit, trustees have an obligation to their sponsors and members to make sure the levy accurately reflects the risks their fund poses to the PPF.
WHAT IS THE LEVY?
The PPF levy, alongside asset recoveries from insolvent pension funds, is one of the ways the PPF funds the compensation payable to members of schemes that transfer into it.
All UK defined benefit final salary pension schemes must pay it if their members would be eligible for PPF compensation in the event that their scheme’s employer becomes insolvent, and there are not enough assets remaining in the scheme to pay benefits at PPF levels of compensation.
Something as trivial as a change of address or director could have an impact on the credit rating.
The levy is charged annually, and each year the board of the PPF is required by law to consult if any of the levy factors or levy rates differs from the previous year, and publish an estimate of how much the current rules collect. For 2016/17, that estimate is £615m.
HOW IS IT CALCULATED?
The PPF levy is split into two components. The scheme-based levy, calculated as a percentage of a scheme’s total liabilities, is a relatively straightforward component.
The risk-based levy is generally larger, and more complex. It is based on the likelihood of a scheme making a claim on the PPF and the potential size of that claim, and takes into account insolvency risk and underfunding risk.
THE TWO COMPONENTS
SCHEME-BASED LEVY this is based on a scheme’s liabilities on a section 179 basis. This cannot make up more than 20% of the total that the PPF aim to collect.
RISK-BASED LEVY this takes account of the risk of a scheme’s sponsoring employer becoming insolvent (insolvency risk) and the amount of compensation that might then be payable by the PPF (underfunding risk). It makes up at least 90% of the total that the PPF aim to collect, though some schemes with very low levels of risk may not have to pay the risk-based levy.
MAKING SURE YOU PAY THE RIGHT LEVY
Clive Pugh, partner at Burges Salmon, says trustees should pay attention to the formalities of providing levy information.
He says: “It’s in the interests of trustees to help. Working with the credit agency to ensure there is a proper understanding, because something as trivial as a change of address or change of director that doesn’t really relate to the strength of the business could have an impact on the credit rating.”
Pugh believes that although seemingly trivial, even little checks such as these can make a difference.
Gary Daniel, principal at AON agrees that trustees should be monitoring their credit score, and understanding the reasons behind any changes in that score.
He says: “We believe in marginal gains, if each component can be squeezed a little bit, then overall it can have a material impact on the liabilities.”
The most recent PPF scoring model operated by Experian has resulted in scores that are more stable than the old Dun & Bradstreet system that was used until March 2014.
Furthermore, the scores used to calculate the key components of the levy are available on a portal provided by Experian for both trustees and employers to monitor on a daily basis. This was introduced in the current triennium, enabling more transparency on how the score is calculated.
Julia Dickson, a partner at PwC, thinks that trustees need to be far more proactive. As Experian sources its information primarily from Companies House, Dickson recommends trustees should put forward any information about their employers that is not readily available, so that the information held on the Experian portal accurately reflects the accounts of the employers.
Dickson explains: “With regards to data, what is being used in respect of the employers comes originally from the annual scheme return that schemes are required to submit to the Pensions Regulator. So familiarise yourself with that, and make sure that information submitted was correct in the first place.”
Daniel agrees: “We’re advocating being more proactive and more sophisticated. Our general rule of thumb is that if the reduction in levy is greater than the cost of undertaking the action, then it’s definitely worth doing.”
Daniel encourages clients to provide the most up-to-date funding figures possible. Section 179 funding valuations have historically been done every three years, in line with scheme valuations.
He says: “We noticed it’s advantageous to do ‘out of cycle’ 179 valuations. A number of clients are now doing it annually, and then assessing whether to submit it for that particular year. We’ve seen a trend that the more recent the 179 valuation is, the more beneficial it will be to submit.”
WORKING MORE CLOSELY WITH EMPLOYERS
In addition to ensuring credit ratings and data held is accurate, Burges Salmon’s Pugh thinks trustees should open up a wider conversation about security.
He says: “The PPF levy can start a dialogue that says: ‘While we want cash and funding says we should get cash, if you can get us a better security package that means more cash in the business’.”
The levy should be a genuine reflection of the business and its strength. If trustees want to get the levy down, a key way is to make sure the employer covenant stronger, explains Pugh.
“If you could swap in another business, or add in a new business as a statutory employer or last person standing, in my view that is something the PPF would be positive about because yes, the PPF is getting less levy money from them, but it’s also reducing the likelihood that the PPF will have to pay out that money in the long run.”
Pugh has seen that trustees have become used to checking formalities now, but there is still not as much focus yet on the wider dialogue, so he believes there is more that can be done here to get trustees and the employers more closely aligned.
Trustees should be looking at the position of the scheme in the event of a sponsor insolvency, and whether this could be improved. The PPF does reviews each year to check that in a hypothetical situation when faced with insolvency, any guarantor is good for the money to back up its guarantee.
The onus lies with trustees to certify that by the 31 March each year, they are confident that the ‘realisable recovery’ amount can be supported by the guarantor.
They need to understand what assets and sources of liquidity that guarantor has as a standalone company, and what would happen to that guarantor in the event of an insolvency, to establish whether they could still back the scheme if needed.
The levy is now an established part of the DB landscape, and plays a vital role in providing security for members. But schemes have a duty to make sure that they’re paying the right amount.