27 April 2020
The amount of money which some companies have to pay into the Pension Protection Fund (PPF) could rise threefold as a result of the current crisis, according to new analysis by pension consultants LCP. The worst-affected firms could potentially face see their annual levy payments into the PPF rise by a million pounds or more.
Each year, the PPF raises a levy on Defined Benefit pension schemes and in 2020/21 the total bill is set to raise £620m. The bill is often passed straight on to the sponsoring employer. The Coronavirus crisis is likely to lead to an overall increase in the size of the levy across all firms, but individual firms may face much bigger increases, particularly if their scheme deficit has increased or if their own solvency position has weakened.
Individual firms may face a ‘perfect storm’ of three factors which could lead to large increases in PPF bills. These are:
- The overall funding position of the PPF is likely to deteriorate as a higher-than-expected level of corporate insolvencies leads to more claims on the PPF; this is likely to lead to across-the-board increases in levies; the funding of the PPF is already likely to come under pressure if changes to the way in which the RPI is calculated result in a reduction in the income from index-linked gilts (thankfully there is a cap on the amount of the overall levy increase);
- The funding position of individual DB pension funds may have deteriorated substantially because of the current crisis; key factors include:
- Falls in asset values, especially for schemes heavily invested in equities;
- Increases in the value of liabilities, as discount rates might now be expected to stay ‘lower for longer’;
- Suspension of pension contributions to ease employers’ cash flow during the crisis
- Individual firms, especially those in sectors hardest hit by the crisis, may be judged to be at a higher risk of going insolvent, and this increases the amount of ‘risk-based’ levy they have to pay to the PPF.
Firms are currently put in one of ten bands according to their assessed risk of going insolvent, with Band 1 the lowest risk and Band 10 the highest risk. A company that was in Band 4 before the crisis and saw a big economic hit to profits, turnover and cashflow could realistically find themselves in Band 7 at the next assessment. As firms in Band 7 pay more than three times the PPF levy rate than firms in Band 4, such a change could lead to a trebling of bills, some larger firms seeing million pound increases. The first increases would affect levy payments for 2021/22, though the full effect might not be felt for a number of years.
LCP specialists say that there are several things that firms can do if they think this could apply to them:
- Make sure that the new method of measuring insolvency risk (introduced this April) accurately captures the company’s true financial position;
- Review whether giving the pension scheme some extra security – for example through parent company guarantees – would help to reduce the risk to the PPF and thereby scale back any levy increase;
- Consider whether other more technical mitigation actions might help, such as confirming to the regulator that deficit contributions have been paid, and that pension investment risk is being measured and managed appropriately.
Commenting, Alex Waite, partner at LCP said:
‘The Pension Protection Fund is strong enough to withstand the present crisis, but it is likely to need to raise more in levies, with some firms facing particularly large increases. A rise in corporate insolvencies will put increased pressure on PPF levies across the board. But individual firms could see a much more dramatic change. If their pension scheme deficit has increased and if their own insolvency risk has also risen, this ‘perfect storm’ could eventually see million pound levy increases for some employers. It is vital that employers plan ahead so that they are not caught unawares by potentially large future levy increases’.