Pope Anderson LLP

Introduction

In November 2008 the Pension Protection Fund (PPF) published its final determination on how 2009/10 PPF levies will be calculated. This makes it possible for schemes to calculate their 2009/10 levy with accuracy. This purpose of this note is to summarise the main changes from last year and reiterate how the levy is calculated.

2009/10 PPF levies - key changes

After being roundly criticized over their decision to increase the final 2008/09 risk based scaling by a whopping 250% over previous announcements, for 2009/10 the PPF were keen keep to changes to a minimum. The main changes and points to note are set out below:

• The PPF confirmed it’s intention to collect £700m in levies for 2009/10, in line with its 2007 proposals to collect an amount of £675m indexed with earnings for 2009/10.
• The risk based scaling factor and scheme based multiplier calculated to collect this amount will be 2.22 and 0.000162 respectively 2009/10. This compares with factors of 3.77 and 0.000165 respectively used to calculate the final 2008/9 levies.
• The underfunding and insolvency risks for the 2009/10 levy will be assessed at 31 March 2008 using scheme information held by the Pensions Regulator at midnight on 31 March 2008.
• Schemes can submit certificates for Deficit Reduction Contributions and register contingent assets to reduce their 2009/10 PPF Levies.
• Partial Block Transfers made after 31 March 2008 will not be taken into account for the 2009/10 levy. Full Block Transfers after this date must still be notified to the PPF for it to update its records and ensure it does not lose revenue.
• Submission of information and certificates will now be made via the Pensions Regulators Exchange system.

Background

The Pension Protection Fund (PPF) was established in 2005 to provide compensation to members of defined benefit pension schemes where the sponsoring employer becomes insolvent and the scheme is unable to provide the PPF level of compensation to members.

Broadly, the compensation provided by the PPF are the scheme benefits with the following adjustments:

• A 10% reduction to benefits for all members under the scheme normal retirement age.
• Applying the PPF compensation cap (£30,856 for 2008/09) for members under normal retirement age.
• Pension increases of RPI capped at 2.5% for service after 6 April 1997 only. No pension increases awarded for service before this date.
• A spouse’s reversionary pension of 50% of the members PPF pension.
• Deferred pension increases of RPI capped at 5.0% for future revaluation until normal retirement age.

The PPF is funded out of the assets of failed schemes and levies paid annually by eligible pension schemes. The PPF carries out periodic projections of the amount of levy it will need to collect and uses these to set the formulae on which the levies are be calculated. For 2009/10 the PPF plans to collect £700m in levies, in line with forecasts made in 2007.

The PPF levy comprises two parts:

• A risk based levy calculated with reference to the level of funding of the scheme and the strength of the employer. 80% of the total levy collected is intended to be risk based.
• A scheme based levy calculated with reference to the absolute value of the PPF liabilities. 20% of the total levy collected is intended to be scheme based.

This does not mean that each scheme’s individual levy will be split 80% risk based and 20% scheme based. The 80/20 split applies to how the PPF intends to raise its overall levy.

To enable the PPF to calculate levies all eligible pension schemes are required to submit annual returns to the Regulator containing information about the scheme, its membership, assets, Section 179 funding levels and information on the participating employers.

The PPF has appointed Dun & Bradstreet (D&B), the credit specialist, to calculate the failure score of each sponsoring employer which is used to calculate the risk based levy.

Determining the PPF Levy

The scheme based levy

The 2009/10 scheme based levy will be calculated using the formula below:

Scheme based levy = L  x  h

L is the estimated amount of the scheme’s PPF liabilities at 31 March 2008 and h is the scheme based multiplier - set at 0.000162 for 2009/10.

The risk based levy

The 2009/10 risk based levy for a scheme will be:

Risk based levy = U  x  P  x  R  x  c

U is the underfunding of the scheme and is a percentage of the scheme’s liabilities at 31 March 2008 in accordance with the table below:

Dun & Bradstreet provide the PPF with a failure score between one and one hundred as at 31 March 2008 for each sponsoring employer and P is the assumed insolvency probability associated with the failure score. Sample insolvency risk factors are set out below:

Where a D&B Failure Score cannot be obtained, the PPF Board will use the average for sponsoring employers in the appropriate industry sector. 

R is the proportion of the total levy intended to be risk based and is 0.8 for 2009/10 and c, the risk based scaling factor, is 2.22.

The total levy is the sum of the scheme and risk based levies. To protect the weakest schemes (i.e. those with the highest failure risk and lowest funding), there will be a cap on the individual risk based levy for each scheme of 1.0% of the estimated PPF liabilities.

The Section 179 Valuation – assessing the PPF Assets and Liabilities

All eligible pension schemes are required to carry out an actuarial valuation meeting the criteria specified in Section 179 of the Pensions Act 2004. Broadly a Section 179 valuation is a buy-out valuation calculated using the assumptions prescribed by the PPF and allowing for the level of compensation payable by the PPF. Trustees were required to have carried out and submitted their first Section 179 valuations by 31 March 2008.

The PPF will roll up the results of these Section 179 valuations to 31 March 2008 (the assessment date) and use the estimated Section 179 liability at this date for 2009/10 levy calculations.

Scheme assets will be taken at their market value and similarly rolled up to 31 March 2008. In rolling up the assets the PPF makes allowance for the split of assets by asset class and assumes that assets in each class perform in line with market indices. The asset value will then be adjusted to include any Deficit Reduction Contributions or Contingent Assets and used to calculate the PPF funding level at 31 March 2008.

Note that some investments (e.g. targeted return funds) don’t fit easily into the PPF’s roll up model and the PPF makes broads assumptions about how these change with market conditions. In addition some managers may have outperformed the market indices the PPF uses to roll up assets. The trustees of these schemes may want to consider if it is worth commissioning a new, out of cycle Section 179 valuation to get a more accurate 2010/11 PPF levy that allows for these issues.

Deficit Reduction Contributions

To allow for any action taken by the employer since the last Section 179 valuation to tackle a deficit, trustees can submit a Certificate of Deficit Reduction Contributions. For the 2009/10 levy this certificate must be submitted by 7 April 2009.

Contingent Assets

Provided they are put in place using the PPF’s standard documentation and certified by the relevant deadline, the PPF will take account of contingent assets (i.e. assets that will produce cash for the scheme in the event of employer insolvency) when calculating the risk based levy.

The types of contingent assets that can be taken into account are:

1. Group company guarantees;
2. Security over cash, property or securities;
3. Letters of credit and bank guarantees.

The trustees will be required to obtain a legal opinion that any guarantee is legally valid, binding, and enforceable. It will then need to be certified, and submitted to the PPF no later than 31 March 2009 for inclusion in the calculation of the 2009/10 levy.

Multi - Employer Schemes

The PPF make special arrangements for calculating the insolvency probability, P, for schemes with more than one participating employer. The treatment will depend on the precise legal structure of the scheme.

Where the rules include a requirement or discretion to segregate on cessation of a participating employer, the insolvency probability is calculated as an average of the insolvency probability of each participating employer weighted by the number of members with each employer. Where the scheme has a “last man standing” structure, i.e. there is no requirement or ability to segregate on the cessation of a participating employer, the insolvency probability is calculated as 90% of the weighted average insolvency probability for each employer.

Block Transfers

Some pension schemes may have been involved in a bulk or block transfer after their last Section 179 valuation and this will need to be allowed for in the PPF levy. This is done by submitting a two-part Block Transfer Certificate.

For the 2009/10 levy, as underfunding is being measured at 31 March 2008 partial block transfers occurring after 31 March 2008 will not be taken into account. The PPF will still need to be informed about full block transfers to ensure liabilities are not ‘lost’ and the PPF does not lose revenue.

What will our 2009/2010 Levy be?

This is will be a key question for trustee and employers. The November 2008 announcement from the PPF means trustees and employers can now calculate their 2009/10 PPF levies with accuracy.

Please get in touch with your usual Pope Anderson contact if you would like an estimate of your 2009/10 and 2010/11 PPF levies and advice on how the levy can be managed.

PPF Levies for 2010/11 and onward

Schemes will be receiving notification that a return is due over the next few weeks. The deadline for amending information contained in the scheme return is 31 March 2009 for the calculation of 2010/11 levy.

In their September 2008 consultation document (on 2009/10 levies), the PPF stated they had learnt from past experience and now recognised that any significant changes should be introduced in a measured way which allowed schemes to respond to any changes. They said that for this reason schemes can expect the levy for 2010/11 to be similar to that in 2009/10.

In November 2008 the PPF issued a consultation document on their proposals for the 2011/12 levy and beyond. They reiterated their intention to make few changes for 2010/11 and proposed a completely new approach and formulae for 2011/12 and beyond.

Although we expect the levy formulae for 2010/11 to be similar to that for 2009/10 this does not mean that the amount of an individual schemes levy will be the same. Since 31 March 2008 (the assessment date for the 2009/10 levy) financial markets have crashed, bringing down the value of pension schemes assets and the D&B ratings of many UK companies. The underfunding and insolvency risks, as assessed by the PPF, are likely to be larger and therefore we can expect 2010/11 levies for many schemes will be larger as well.

The November 2008 consultation document has detailed proposals of the PPF intended approach to levies for 2011/12 and onward. We are in the process of reviewing this and will send our comments in due course. 

Actions for Company / Trustees and Important Dates

 2009 / 2010 PPF Levy

• The measurement date for underfunding and insolvency risk is 31 March 2008.
• The deadline for submission of scheme return data including the Section 179 valuation was 31 March 2008.
• The deadline for certification of contingent assets is 31 March 2009.
• The deadline for submission of the certificate of deficit reduction contributions is 7 April 2009.
• Full Block Transfers much be notified by 7 April 2009 and final certification of full block transfers is due by 30 June 2009.

2010 / 2011 PPF Levy

The provisional deadlines for the 2010/11 levy are:

• Scheme return information submitted by 31 March 2009.
• Queries on Dun & Bradstreet failure scores to be submitted by 31 March 2009.
• For block transfers taking place before 31 March 2009 notification must be given by 7 April 2009 with final certification by 30 June 2009.
• For block transfers taking place before 31 March 2010 notification must be given by 7 April 2010 with final certification by 30 June 2010
• The deadline for certification of contingent assets is 31 March 2010.
• The deadline for submission of the certificate of deficit reduction contributions is 7 April 2010.
• Full Block Transfers much be notified by 7 April 2009 and final certification of full block transfers is due by 30 June 2009.