In this December 2011 edition of Pensions Extra, we highlight the key aspects of the new levy framework published by the Pensions Protection Fund (PPF). Following various announcements and consultations, the PPF has finalised the pension protection levy for the PPF’s financial year 1 April 2012 to 31 March 2013, and has published its formal levy determination. We have taken the step of issuing an extra bulletin on this topic given that the final framework makes various key changes to the levy regime. Trustees, employers and advisers ought to consider the impact of these changes on their schemes, and take action both to address any issues arising and to ensure compliance with the new framework well in advance of the 2012/13 levy year commencing.

The PPF levy

The PPF imposes various levies on eligible defined benefit occupational pension schemes. The most significant is the pension protection levy, often referred to as the PPF levy, which is used to fund the compensation paid to members of schemes which enter the PPF.

An annual PPF levy is calculated for each eligible pension scheme based on the scheme’s position immediately before the commencement of the levy year on 1 April. A maximum of 20% of the total levy is based on the scheme’s membership and liabilities. The remainder is a risk-based levy based on the level of underfunding in the scheme (i.e. the deficit) and the likelihood of the scheme entering the PPF in the following year (i.e. the probability of insolvency of the scheme employer(s)). Underfunding risk is calculated using the scheme’s most recent section 179 valuation. Insolvency probability is calculated by Dun & Bradstreet (D&B) who attribute a “failure score” to each employer.

The 2012/13 levy determination

The PPF has confirmed that for the coming three levy years the overall amount to be collected annually (the “levy estimate”) will be £550 million. This is a reduction from £600 million for 2011/12. The PPF has also confirmed the details of its new levy framework, which will be used to calculate individual levy bills for the same period.

What are the key aspects of the new levy framework?

The key aspects of the new levy framework are as follows:

Fixed levy estimates and rules
The new levy estimate and framework are fixed for three years to afford greater certainty and allow schemes to plan for their levy bills and to take risk reduction measures.

Type A contingent assets

PPF compliant contingent assets are a common measure adopted by schemes seeking to reduce the risk-based levy. The PPF views such measures as potentially reducing either the risk of an employer insolvency event or the size of any claim on the PPF.

The new framework introduces changes to the certification regime in respect of Type A contingent assets, that is parent or group company guarantees. A Type A contingent asset involves a group company guaranteeing the scheme liabilities to a specified level in the event of the insolvency of the scheme employer(s). Having compared the extent of a number of guarantors’ obligations against publicly available information on the companies’ financial strength, the PPF has raised concerns regarding the ability of some guarantors to meet their guaranteed obligations.

Addressing this concern, the new framework provides that with effect from 2012/13 trustees certifying or recertifying a Type A contingent asset on Exchange will require to certify that as at the date of the certificate, they have no reason to believe that the guarantor could not meet its full commitment under the contingent asset. There will be an option to certify less than the face value of the contingent asset if the trustees feel a lower amount is more appropriate.

Prior to certifying a Type A contingent asset, trustees should take “proportionate and reasonable” steps to reassure themselves as to the financial strength of the guarantor. This could involve, amongst other steps, reviewing the company’s latest accounts and/or considering the liquidity of its assets. The PPF has indicated an intention to complete its own investigations in respect of guarantors’ strength.

With the deadline for certification of contingent assets of 30 March 2012 looming, trustees ought to start considering how they will assess the strength of their guarantors, and whether they will be able to certify on this new basis. It is likely that this new requirement will result in the PPF rejecting some contingent assets which it has previously recognised.

An addition change in respect of Type A contingent assets relates to multi-employer schemes. With effect from the 2012/13 levy year, the guarantor’s insolvency risk will only be substituted for those employers with a higher risk of insolvency, allowing employers with lower insolvency risks to retain these for levy calculation purposes.

Expanded definition of “associate”
The new framework also relaxes the current requirement that a guarantor or charger in respect of a contingent asset be an “associate” of a scheme employer. The definition of “associate” is extended to include those with a pre-existing commercial or legal relationship with a scheme employer, provided that relationship has not been manufactured for the purposes of giving the contingent asset. The PPF will require to be satisfied both that the contingent asset was given as a result of the pre-existing relationship and that the person giving the contingent asset has a genuine and substantial reason for doing so, regardless of any payment or other consideration received by it as a result.

Underfunding risk
Underfunding will no longer be calculated on the basis of a scheme’s assets and liabilities on a specific date. Instead the daily average of appropriate indices and rates over five years (i.e. for 2012/13, the five year period to 30 March 2012) will be applied to smooth scheme funding and reduce the influence of short-term volatility in the market.

In addition, investment risk will be included in the calculation of the PPF levy for the first time in 2012/13 via the application of a standard stress factor to a scheme’s asset value. The stress factor applied will vary by asset class. Investment risk will be calculated using the information on a scheme’s asset portfolio provided through Exchange. Schemes should ensure that full and accurate asset details are provided as, for example, setting out the asset split in a pooled fund can lead to a levy reduction.

Schemes with liabilities of £1.5 billion or more will have to make their own assessment of investment risk by adopting a tailored stress test based on criteria set by the PPF. Other schemes may elect to adopt a bespoke approach. Trustees and their advisers may wish to consider whether there is merit in completing their own assessment.

Insolvency risk

Going forward, insolvency risk will be based on an average of monthly failure scores over the preceding 12 months to the end of March and not a year in advance as before. Failure scores will be allocated to one of 10 risk bands corresponding to a different levy rate.

Reminder on deadlines

The key deadlines in respect of the calculation of the 2012/13 PPF levy are as follows:

  • Monthly D&B failure scores for levy year 2012/13 are being collected between 28 April 2011 and 30 March 2012. Information provided by month end will be used to update failure scores for the following month so schemes will want to ensure they update D&B promptly regarding any changes.
  • Updated scheme return must be submitted on Exchange by 5pm on 30 March 2012.
  • Contingent assets must be certified/recertified by 5pm on 30 March 2012.
  • Deficit reduction contributions must be certified and submitted by 5pm on 10 April 2012.
  • Full block transfers must be notified by 5pm on 29 June 2012.
  • Invoicing on the basis of the new framework will begin in autumn 2012.

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