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PPF levy – Why pay more?

Changes to the Pension Protection Fund levy could result with employers paying more than their fair share, warns Nick Griggs

02 Mar 2012

By Nick Griggs, Barnett Waddingham

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THE PENSION Protection Fund (PPF) levy has become a considerable expense for many sponsors of defined benefit pension schemes. The PPF levy is akin to an insurance premium and the pension schemes that are perceived to pose the greatest risk pay the highest levies. Unfortunately this often means that an employer will be asked to pay a higher levy at a time when it can least afford it.

Last year, the PPF confirmed changes to the formula used to calculate the PPF levy designed to make it more stable from year-to-year. These changes have been widely welcomed by the pensions industry but employers should ensure they are not paying more than their fair share of the £550m that will be collected by the PPF in levies this year.

The changes to the levy formula are significant and scheme sponsors could see a significant increase or decrease in their levy even if other factors, such as their credit rating, remain broadly unchanged. Therefore, your first priority should be to get an estimate of the levy under the new formula to assess the potential to make savings.

One of the main changes to the levy formula was in the assessment of the insolvency risk posed by the sponsoring employer. Previously, sponsors only needed to ensure that their Dun and Bradstreet (D&B) rating was as good as possible on 31 March each year.

However, the PPF now consider D&B's view of the company over the whole year by averaging the failure scores recorded at the end of each month over the year to 31 March. This approach will lead to greater stability and predictability to the levy calculation but it places an extra burden on companies to monitor their rating continuously.

In an effort to further increase the stability of the levy from one year to the next the PPF has replaced the previous 1-100 scoring system with ten insolvency risk bands. Your average rating over the year to 31 March will determine which band you fall into.

We are now nearing the end of the averaging period, but if an entity's average is close to the edge of one of the 10 insolvency risk bands, a small change in the next few weeks could result in a significant change in their levy if the average score were to move into a higher or lower band. The change could be as much as a 60% increase or a 35% decrease in the main risk based element of the levy. Therefore it is vital for you as the sponsoring employer of a scheme to take action now.

Scoring methodology

It is important to fully understand D&B's scoring methodology. Often the biggest drivers to an improvement in an entity's credit rating are quite surprising - and it can be very frustrating with the benefit of hindsight to realise that a fairly simple change in practice or even an amendment to incorrect data held by D&B could have prevented a big hike in the PPF levy.

For example, D&B collects over 100 million trade payment experiences and there will be incorrectly recorded late payments within this data that will have an adverse impact on an entity's failure score. Employers should ensure errors are removed from their D&B record.

The sponsoring employer should also consider the savings that can be made by providing the pension scheme with additional non cash security. This can take the form of a guarantee from another stronger entity in the group or at least one that in D&B's view is stronger.

Alternatively a charge over an asset such as a property can significantly reduce the levy. This security can also be useful in negotiating with the trustees during the actuarial valuation process over the level of deficit contributions payable.

The 2012/13 PPF levy will for the first time take account of a scheme's investment strategies. Details of this will be taken from the scheme return submitted to the pensions regulator. It is important to consider the information disclosed carefully as classification of certain investment funds could be made in different ways with a significant impact on the levy. There is also an option to provide extra, more detailed, information particularly where the scheme has adopted an "LDI" strategy.

Time is now running out to minimise the levy invoice you will receive later this year and small changes can in some cases lead to massive savings.

Nick Griggs is a partner at Barnett Waddingham

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