Pension Protection Fund - Levies

Levies

The PPF is funded by levies on all eligible defined benefit schemes.

In the first year of operation the PPF levy was a flat rate amount per member of the scheme.

After the first year of operation the levy is based on a scheme based element and a risk based element:

• 20% of the pension protection levy will be raised via the Scheme Levy.

• 80% of the pension protection levy will be raised via the risk-based levy. This levy depends on the level of underfunding in the scheme and the probability of the employer becoming insolvent over the following year. The probability of insolvency is estimated by Dun & Bradstreet.

There is also an administration levy charged each year to provide for ongoing running costs. Together, the scheme-based levy and the risk-based levy make up the total PPF levy. The scheme-based levy is just proportional to the scheme’s PPF protected liabilities, where the long-term factor of proportionality is set to ensure that the scheme-based element comprises approximately 20 per cent of the pension fund levy. The PPF protected liability is the level of compensation that would be paid if the scheme were transferred to the PPF, it can either be the complete actuarial valuation according to section 179 of the Pensions Act 2004 or the adapted MFR (minimum funding requirement) liability, and normally it should be smaller than the ‘true’ pension liabilities given by FRS17 or IAS19 liabilities.

In order to calculate the risk-based levy the Board of the Pension Protection Fund considers the level of scheme underfunding (underfunding risk) and the likelihood of sponsoring employer insolvency (insolvency risk) and may also consider the asset allocation and any other risk factors that may be prescribed in regulations when setting the risk-based pension protection levy, which is reflected in the levy scaling factor the Board sets up and updates annually. The PPF assumed probability of insolvency is calculated in conjunction with a third party provider. In 2006/07 this was Dunn & Bradstreet (D&B). The assumed probability of insolvency for the risk-based levy is calculated by identifying each participating scheme as being in one of the 100 risk bands related to the D&B failure score (the higher the score the lower the insolvency risk). Each risk band has an associated assumed probability of insolvency which is capped at 15%.

An eligible pension scheme covered by PPF can either be sponsored by a single employer (single-employer scheme) or more than one employer (multi-employer scheme) and many of the largest 500 pension schemes are multi-employer schemes with over 100,000 participating sponsoring employers between them. For a single-employer scheme the Board only needs to consider the risks underlying this individual employer when calculating the pension protection levy. However the risks faced by a multi-employer scheme may be different to those faced by single-employer schemes. The structure and the rules of different types of schemes have an impact on how the risk is shared among participating employers and therefore on the calculation of levy risk factors. Multi-employer schemes are classified into several categories according to the Pension Protection Fund (Multi-employer Schemes) (Modification) Regulations 2005 (or the Pension Protection Fund (Multi-employer Schemes) (Modification) Regulations (Northern Ireland) 2005) depending on whether the employers in the scheme are from the same or similar sectors (sectionalised/non sectionalised) and whether the scheme has an option or requirement to segregate upon cessation of a participating employer.

For schemes with neither a requirement nor discretion to segregate on cessation of participation of an employer a ‘last-man-standing (LMS)’ pension protection levy applies, under which the Board will not trigger an ‘assessment period’ until the last employer in that scheme becomes insolvent. For multi-employer sections/schemes with an option or requirement to segregate on cessation of participation, the scheme pays a ‘segmented’ levy, which means each sponsoring employer is only responsible for its own pension liabilities and in the event of insolvency, only the insolvent firm’s pension liabilities are transferred to the PPF, not the whole scheme.

For both LMS and segmented multi-employer schemes the insolvency risk is calculated as the weighted average probability of insolvency for all participating sponsoring employers, but in the case of an LMS arrangement, these probabilities are adjusted by a scaling factor (< 1) to reflect the degree of correlation across the employers in the scheme. The PPF defines an associated pension scheme as one that has more than one sponsoring employer and where the sponsoring employers are financially dependent or linked to the same parent company .For associated schemes the scaling factor is 0.9 whilst for non-associated schemes the scaling factor is the ratio between members of the largest employer and the total number of members for the entire scheme.

Hence, the scaling factor ensures that the last-man-standing risk-based levy is lower, but raises a cross-subsidy issue, since an insolvent participating employer will be funded by the rest of the employers in the set of multi-employers. The Universities Superanuation Scheme (USS) is an example of a multi-employer scheme covering 391 universities and related institutions. Liu and Tonks (2009) assess whether levy payments made by USS reflect the underlying risks of the participating institutions.