Pensions lifeboat promises hope for sinking schemes
The aim of the Pension Protection Fund is to provide increased protection for members of defined-benefit and hybrid schemes by paying compensation when an employer becomes insolvent and the scheme is underfunded. In the first part of our guidance feature we examine the PPF levies and the process that schemes wishing to apply for compensation must follow.
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From April 2006, the PPF will be funded by three levies - the PPF compensation levy, the administration levy and the PPF Ombudsman levy. In the first year, two levies are in operation: the initial levy (which will be replaced by the PPF compensation levy) and the administration levy.
The amount needed to fund the PPF compensation levy will exceed £300 million. The annual administrative costs are expected to amount to approximately £15 million.
DB schemes and hybrid arrangements are eligible for the PPF. Also included are schemes that are partially guaranteed by the Crown.
The PPF is currently consulting on the details of the compensation levy, which will be introduced in 2006. To calculate this, the PPF Board will require schemes to carry out an actuarial valuation on a prescribed basis, so the level of schemes' underfunding can be ascertained consistently.
A scheme is eligible for entry into the PPF if: it has not commenced winding up prior to
During the assessment period, which is likely to last for a minimum of one year, stringent restrictions are put on the pension scheme.
Trustees have several responsibilities during this period, which include carrying out a review of the scheme rules, passing on information to the PPF Board, paying out scheme benefits at PPF levels, and communicating with members.
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According to Alan Johnson, former Secretary of State for Work and Pensions, the Pension Protection Fund (PPF) will not only "end the scandal of people losing their pension when their company goes bust", it will also enhance the value of the occupational pensions offered by "good" employers. Despite concerns among scheme sponsors and sections of the pensions industry about the cost and viability of the PPF, there is a general consensus that the fundamental aims of the scheme are laudable.
The PPF is intended to reassure members of defined-benefit (DB) and hybrid schemes that they will receive the greater part of the benefits they have been promised, even if their employer goes bust. The body, which opened for business on 6 April 2005, has the power to take on the assets of underfunded schemes where the sponsoring employer becomes insolvent. Most importantly, it will then take responsibility for paying out "compensation" to members, who would otherwise lose out.
The provisions for the PPF take up approximately one-third of the 366 pages of the Pensions Act 2004 and, so far, 26 sets of regulations have been issued. Our two-part feature provides a guide to this legislation.
In this article we describe how the PPF will operate, its funding and how schemes will be assessed for eligibility for compensation. In the second part, being published next month, we deal with the outcome of applications to the PPF, the PPF's role once it has taken over a pension scheme and the levels of compensation paid out to members.
PPF Board
The PPF is a statutory fund run by the PPF Board - a statutory corporation established under the provisions of the Pensions Act 2004. PPF compensation will be funded by taking on the assets of pension schemes with insolvent employers, and through a levy on DB schemes and on the DB element of hybrid schemes.
The board is made up of a majority of non-executive members and is currently chaired by Lawrence Churchill, one of the non-executive members. The mix of staff, the chief executive and non-executives is designed to ensure an appropriate balance of independence and accountability. The board's functions include:
paying compensation to members when the PPF takes over an ailing scheme;
calculating annual levies to fund compensation payments and administration (payable by eligible schemes); and
setting and overseeing the investment strategy of the PPF.
The board will also manage the fraud compensation fund, which is to be transferred from the existing Pension Compensation Board in September 2005. The ongoing cost of this will be met by a fraud compensation levy, the terms of which will be determined by the board. Details of this are not yet available.
The board must appoint at least two fund managers to oversee the PPF investments and it must have a statement of investment principles (See Total annual pension levy to top £300 million for brief details of the current statement of investment principles and fund manager appointments). Any income or capital arising from the investment of PPF assets must be retained in the PPF. The board has been given powers to borrow up to £25 million1.
PPF setup
For tax purposes, the PPF is to be treated as an approved pension scheme (a "registered" scheme when the new simplified tax regime commences in 2006). This means that tax relief will be allowed for payment of the statutory levies to the PPF, for example where a sponsoring employer provides a scheme with funding for the levy payments.
Speaking about
the design of the PPF at a Pensions Management Institute conference, Churchill
said that the
Scheme levies
The PPF will be funded by three levies, which will be collected by the Pensions Regulator. These cover the payment of pension compensation (the "PPF levy"), administration of the PPF Board (the "administration levy"), and the PPF Ombudsman levy. The levies are payable annually by the trustees (or scheme managers where there are no trustees) of "eligible" schemes, although the Pensions Bill Regulatory Impact Assessment2 notes that the government expects that, in practice, sponsoring employers will bear the brunt of the cost of the levies.
The government estimates (in the same document) that the amount needed to fund the compensation payments will be approximately £300 million a year and the annual administrative costs will amount to approximately £15 million. A more recent PPF consultation document has indicated that the total cost of the pension protection levy payments will in fact be "somewhat higher".
Schemes eligible for the PPF include DB and hybrid arrangements and the unsecured part of schemes that are partially guaranteed by the Crown (that is, where a government body has provided a guarantee that liabilities relating to part of the scheme will be met in full). Where a hybrid arrangement is concerned, the levy will not be imposed in respect of any part relating only to money-purchase benefits. Schemes with a partial Crown guarantee will only be liable to pay the levies for the part of the scheme that does not have a guarantee.
The PPF does not cover unfunded public service schemes, public sector schemes providing pensions to local government employees, schemes to which a minister of the Crown has given a full guarantee, schemes with "fewer than two members", and those providing death-in-service benefits only.
Levies in first year
During the
initial 12-month period from
a £15 charge for active and pensioner members, pension credit members (those who have benefited from a pension-sharing order on divorce) in receipt of a pension, and recipients of a dependant's pension; and
a £5 charge for each deferred member and for every pension credit member who is not in receipt of a pension.
Multi-employer schemes will be charged as if each section of the scheme is a separate scheme.
This year's administration levy is calculated
according to the total number of members in the scheme as at
As an example of total PPF levy costs in the first year, a final-salary scheme with 500 members, 100 of whom are deferred pensioners, pays £7,400. For such a scheme with 10,000 members, half with preserved pensions, the cost is £110,600.
Risk-based levy
From 2006, the PPF levy will be made up of two parts. Eighty per cent of the charge will be based on "risk" factors (such as the level of scheme underfunding, the risk of sponsor insolvency and the investments of a scheme relative to its liabilities). The other part of the fee will be assessed with reference to scheme factors such as total scheme liabilities.
Higher levies will be payable by schemes that are poorly funded or whose sponsoring employers have a higher risk of insolvency. This will satisfy the need to ensure that well-funded schemes, which are less likely to need help from the PPF, are not unfairly burdened with disproportionately high costs. The levy arrangement is also designed to encourage DB schemes and employers to maintain as high a funding level as possible.
So that the PPF levy can be calculated on a consistent basis, eligible schemes will need to carry out a valuation on a prescribed valuation basis, as set out in Regulations3 (OP, June 2005). Schemes will need to submit the outcome of this s.179 valuation (so named because its provisions are contained in s.179 of the Pensions Act 2004) to the PPF. After the initial one, the scheme will need to submit further s.179 valuations at least every three years.
PPF consultation
The PPF Board has published a consultation paper on the details of the risk-based. Whereas the original legislation allowed considerable flexibility around the initial submission date of the s.179 valuation, the board proposes that legislation should be changed to require all eligible schemes to provide such a valuation by 31 December 2006. This would enable the risk-based levy to be set on a consistent basis at an earlier date.
Under the law as it stands, schemes have the choice of carrying out the PPF valuation at any point up to 5 April 2008, thus enabling them to tie it in with their normal triennial actuarial valuation cycle. The PPF Board has proposed that, in the interim, where s.179 valuations have not been completed by 31 December 2005, it will use an adjusted minimum funding requirement (MFR) valuation in its place to calculate the levy for 2006/07.
The board proposes to measure the insolvency risk of sponsoring employers of eligible schemes by using a market solution provided by a credit specialist. To protect weaker schemes, it proposes to introduce a cap to ensure that no scheme pays a risk-based levy that is greater than a fixed percentage of its protected liabilities. (Protected liabilities are defined as the total cost of securing benefits at the same level as PPF compensation, winding up the scheme and covering other liabilities not relating to pension scheme members.)
Scheme entry conditions
For the PPF to assume responsibility for a scheme, it must satisfy the following criteria:
it must be "eligible";
the scheme must not have commenced winding up before
the sponsoring employer must have become insolvent (strictly, there must have been a qualifying insolvency event);
there must be no chance that the scheme can be "rescued" (this refers to the possibility of the company being taken over by another employer that is willing to assume responsibility for the pension scheme liabilities); and
there must be insufficient assets in the scheme to secure benefits on winding up that are at least equal to the compensation the PPF would pay if it assumed responsibility for the scheme.
An insolvency event covers a broad range of incidents relating to formal insolvency proceedings, such as the issuance of a court winding-up order, a company entering into administration, and the appointment of an administrative receiver. It does not include members' voluntary liquidation. The insolvency event must occur on or after 6 April 2005 (the occurrence of a previous insolvency event is immaterial).
Where employers have a status that excludes them from having an insolvency event (such as a charity), they may still qualify for PPF entry when it becomes apparent that they are unlikely to continue as a going concern.
Limitations
The PPF Board may decide not to take on the liabilities of a scheme if it considers that, at any time during the three years prior to the "assessment date" (the date of the insolvency event that triggered the beginning of the assessment period), the scheme was not eligible. Where an employer establishes a new scheme and liabilities are transferred from another scheme, the board can also refuse to accept the new scheme. This would be subject to the board being satisfied that the main purpose of the transfer is to enable the members to receive PPF benefits when they otherwise would not.
Regulations also require that the board should refuse admission to a scheme where the amount of debt payable by the employer has been compromised (ie where the trustees have agreed a compromise deal with the employer accepting less than the full amount owing, usually in an attempt to keep the company afloat). There are some limited exceptions to this, for instance, where the PPF has validated a statement that the compromise is above the PPF level of benefits.
Multi-employer schemes that are not split into sections with separate finances will generally only be eligible to enter the PPF if an insolvency event has applied to all the participating employers. Multi-employer schemes that are segregated into financially independent sections will be treated in most circumstances as a separate scheme for PPF purposes, but the precise definition of segregation is not entirely straightforward.
Entering assessment stage
When a qualifying insolvency event occurs in relation to an employer of an eligible scheme, the insolvency practitioner has a duty to notify the PPF, the Pensions Regulator and the scheme trustees about the occurrence. This will trigger the beginning of the PPF assessment period, during which time the PPF Board assesses whether or not it will take on responsibility for the scheme's liabilities. The assessment period runs for a minimum of one year.
Where the sponsoring employer cannot technically become insolvent (because it is an unincorporated charity, for instance), the trustees, pension scheme manager or the Pensions Regulator can trigger the commencement of the assessment by informing the PPF when they become aware that the employer is unlikely to continue as a going concern. This is referred to in the Act as a s.129 application (when made by the trustees) or a s.129 notification (when instigated by the Pensions Regulator).
Once a pension scheme enters the assessment period the PPF Board has to ascertain whether the scheme can or cannot be rescued, and whether the actuarial valuation of the scheme - as at the assessment date - shows that the funds exceed the PPF level of protected liabilities. For this purpose, the Pensions Act 2004 requires that an entry valuation be carried out during the assessment period according to prescribed actuarial assumptions.
In most cases, the PPF Board is likely to approach the trustees of the scheme to ask the existing pension scheme actuary to complete the valuation. Although the assumptions are similar to those prescribed for the s.179 valuation (used as a basis for calculating the PPF levy, see above), there are some differences between the two (OP, June 2005). Actuarial guidance4 on both valuation methods has been issued by the PPF.
During the initial stage of the assessment period, the insolvency practitioner for the sponsoring employer must notify the PPF in writing to confirm whether the scheme has been rescued, or will not be rescued, as the case may be. If a scheme rescue is not possible, the assessment period continues.
Scheme activities on hold
Certain restrictions are put on the scheme while it is being assessed for entry by the PPF. These are:
no benefits can accrue;
no further contributions can be made to the scheme;
no new members may be admitted (other than where the trustees arrange an internal transfer for a pension-sharing credit);
no transfers may be made from the scheme (unless the application was made prior to the assessment period);
benefits paid out will be reduced to the level of PPF benefits;
if a member's pensionable service ends on the commencement of the assessment period, no scheme benefits are payable during this period; and
the scheme may not begin winding up unless the board determines that it is consistent with the objective of ensuring that the scheme can meet the liabilities covered by the PPF.
These conditions end on the date that the scheme is accepted into the PPF, the board notifies the trustees that it is ceasing to be involved, or the scheme completes winding up. If trustees do not take all reasonable steps to secure compliance with the above requirements for the scheme, they are liable to civil penalties.
Trustees' and PPF's responsibilities
During the assessment period, the trustees continue to be responsible for the administration of the scheme, and will also have to cooperate with the PPF in fulfilling its responsibilities. They will need to ensure the benefits are paid at the correct level, communicate with members and provide extensive information to the PPF. Full details of the trustees' role and the support they can expect from the PPF during this time are set out in a PPF guidance document5. A key requirement is that trustees must undertake various preparation tasks ahead of the PPF obtaining an actuarial valuation (such as reconciliation of pension scheme members' details).
The PPF Board has considerable powers over the scheme while it is being assessed for entry into the PPF. Notably, it takes over the trustee's responsibility for the recovery of debts from the employer, which means it becomes responsible for serving any debt on the employer in relation to scheme deficiencies (under s.75 of the Pensions Act 1995), conducting negotiations with the company or its insolvency practitioner in relation to debts, and representing the scheme at creditors' meetings. Charlotte Hoyes of Sacker & Partners comments6 that action taken to recover debts is likely to prolong assessment periods, particularly where a debt is significant enough that its recovery dictates whether or not the scheme will be taken on by the PPF.
During this period, the board also has the power to issue directions to trustees concerning the investment of scheme assets, the incurring of expenditure and the instigation or conduct of legal proceedings. The PPF says that it will "undertake a monitoring role" in relation to the trustees, to ensure they "maintain the scheme in an appropriate manner for potential entry to the PPF". Where a scheme is unable to pay the minimum PPF benefits, the board may also make a temporary loan to the trustees.
Ill-health early retirement and admissible rules
Early in the assessment period the trustees will be expected to carry out a review of the scheme to ascertain whether the current rules in operation are "admissible" in the eyes of the PPF. The review must address:
any changes to pension scheme rules that were made or took effect in the three years before the assessment dates;
discretionary increases to pensions over the same period; and
rules that came into operation by reference to an insolvency event related to the employer.
If the examination establishes that, immediately before the assessment date, the aggregate effect of recent rule changes and/or recent discretionary increases resulted in an overall rise in the pension scheme's liabilities, all of those rules and increases are to be disregarded by the PPF. Those rules and increases that remain are to be known as the "admissible rules". This procedure could be problematic for members, as individuals receiving pensions based on rules that the PPF decides are not admissible could see their benefits reduced or payment deferred.
To try and deter scheme members with inside knowledge about an impending insolvency from taking their benefits earlier than they should (and thereby ensuring 100% of benefits is paid as opposed to the reduced level available in PPF compensation), the Pensions Act 2004 includes certain protective provisions relating to early retirement. Under this legislation, the PPF Board can review any decision to grant early retirement on the grounds of ill health that was granted within three years of the assessment date, or six months after the assessment date (so long as an application was made before that date).
To help the PPF Board fulfil this requirement, trustees must provide information about the ill-health awards made during this period, including any outstanding applications. Where the board considers that the granting of ill-health retirement was inappropriate, it can reduce the benefit payments to nil, and treat the individual as a deferred member of the scheme.
1 "Pension Protection Fund (Limit on Borrowing Order) 2005" (SI 2005/339), available at www.opsi.gov.uk/stat.htm .
2 "Pensions Act 2004: Regulatory Impact Assessment", available from the Department for Work and Pensions website (www.dwp.gov.uk ) via "Resource centre" and "Regulatory Impact Assessments".
3 Pension Protection Fund (Valuation) Regulations 2005 (SI 2005/672), available at www.opsi.gov.uk/stat.htm .
4 "Guidance for undertaking the entry valuation in accordance with Section 143 of the Pensions Act 2004" and "Guidance for undertaking the risk based levy in accordance with Section 179 of the Pensions Act 2004", available from the PPF's website (www.pensionprotectionfund.org.uk ) via "Guidance" and "Valuation Guidance".
5 "Pension Protection Fund: guidance for trustees", available from the PPF's website ( www.pensionprotectionfund.org.uk) via "Guidance", "Guidance for Trustees".
6 "PPF assessment periods: the trustees' roles and responsibilities" by Charlotte Hoyes, PMI News, July 2005, available on the PMI's website (www.pensions-pmi.org.uk ) via "Publications" and "PMI News".
Our research
This feature draws on a reading of the Pensions Act 2004, the accompanying explanatory notes, and the regulations and notes associated with the PPF. We have also used the information and guidance provided by the PPF on its website, and articles in PMI News, factsheets produced by Watson Wyatt, and CMS Cameron McKenna's plain English guide to the Pensions Act.
Calculation Of PPF administration levy due from DB schemes for financial
year ending
|
No. of members in scheme |
Amount of levy per member |
Minimum amount of levy |
|
2-11 |
n/a |
£24 |
|
12-99 |
£2.50 |
n/a |
|
100-999 |
£1.80 |
£250 |
|
1,000-4,999 |
£1.40 |
£1,800 |
|
5,000-9,999 |
£1.06 |
£7,000 |
|
10,000 or more |
£0.74 |
£10,600 |
Source: "Occupational Pension Schemes (Levies) Regulations 2005" (SI 2005/842).
