The PPF projects that it has more money than it is likely to
ever need to meet current and future claims. In this summary, we
set out our view as to how best to deal with that surplus.
At the end of March 2023, under its central assumptions model
the Pension Protection Fund (PPF) had £1.56 of assets for
every £1 of liabilities. Meanwhile, pension scheme funding
has improved to the point where nine out of every 10 schemes would
not call upon the PPF if their sponsoring employer became insolvent
tomorrow. For those that would, the aggregate shortfall is just
£2.2bn, or less than one fifth of PPF reserves.
Against this backdrop, the PPF recently told MPs that it will be
working with the Government between now and 2025 to “develop
an approach for utilising any excess reserves when the level of
risk we face has sufficiently reduced”.
Some might say: not before time. Although the outlook has only
recently appeared quite this rosy, the PPF’s modelling has long
indicated that it was overwhelmingly likely to end up with more
money than it would ever need to pay the compensation set out in
statute. Why would any organisation have no plan for what it thinks
is by far the most likely scenario relating to its core mission?
One answer might be that any unliteral move by the PPF, absent
instruction from Parliament, might be viewed as rash. Another might
have been a fear of appearing complacent.
Why did the PPF surplus arise?
From the start, the PPF charged more in levies than it thought
it would need to make up the shortfall between the assets it could
recover from failed schemes and their sponsors and the cost of
providing compensation. Few would argue that the PPF should have
settled for a 50:50 chance of having enough money, but levy payers
might have been happier about paying a premium if reassured that
this would be refunded once PPF beneficiaries were in a
sufficiently secure position.
The PPF has also invested with the aim of seeing its assets
outperform its liabilities, with the investment risk taken paying
off, while claims following employer insolvencies have been low in
recent years.
Four options for using it
How should any reserves not ultimately needed to pay
compensation at current levels be used? There are four main
options:
- Increase compensation to members and (where relevant) their
dependants<1 - Refund levy payers
- Provide a capital ‘buffer’ if the PPF becomes a
consolidator of solvent employers’ schemes 2 - Absorb the excess into Government coffers
The final two options would be easiest to implement as there
would be a single payee, but they have the least merit.
Transferring funds to the Exchequer would involve PPF levy
payers subsidising the wider population. That may have been
appropriate had legislation required taxpayers to stand behind the
PPF, but this idea was robustly rejected when the Pensions Act 2004
(the Act) went through Parliament. While political pressure might
conceivably have led to a u-turn had the PPF found itself in
difficulty, the circumstances precipitating this would have placed
competing pressures on the public purse. In any case, it would be
extraordinary to justify fiscal transfers on the basis that the
real policy was always the opposite of the one set out in law.
We doubt the wisdom of extending the PPF’s remit to
consolidate solvent employers’ schemes – noting the time it
would take to absorb thousands of schemes, the difficulties in
negotiating “walk away” fees with solvent employers, and
the winners and losers who would be created if benefits were
standardised. Even if this were desirable, the schemes and
employers benefitting from PPF consolidation will be responsible
for only a small share of the PPF’s reserves. Putting reserves
at risk would cut across the principle that any consolidator
should, in the PPF’s description, be “separate” from
the PPF’s Lifeboat function. If a loan were subsequently
repaid, a choice between other options would ultimately be needed.
Levy payers or beneficiaries may prefer a bird in the hand to two
in the bush.
Increasing compensation vs refunding levy payers
Following many hours of debate as the Act made its way through
Parliament, the level of compensation was set so as to balance ease
of administration, perceived needs of different cohorts of member
and to mitigate the risk of ‘moral hazard’. This resulted,
broadly, in the form of compensation with which we are familiar
today:
- A 10% haircut for those below ‘normal pension age’ at
the date of assessment - No increases in payment in respect of pre-1997 accrual and
inflation-proofing (capped at 2.5%) for post-1997 accrual - 50% compensation for surviving partners
- No distinction between Guaranteed Minimum Pension (GMP) and
excess. - A cap on compensation, which was found to breach EU law in
2021, no longer applies, and draft regulations revoke the
cap-related provisions of the Act; the Government has chosen not to
use Brexit as an opportunity to return to the model of compensation
originally envisaged by Parliament.
The simplified structure of
compensation can give rise to losers when a scheme enters the PPF.
In recent months, particular focus has fallen on the modest
‘increase in payment’ provisions given the stubborn spike
in inflation and some have called for the effects on beneficiaries
to be mitigated.
There is a case for this. When PPF compensation was designed,
the expectation was that inflation would remain low. The purchasing
power of PPF compensation is therefore lower than had been
anticipated (also true of pensions in most DB schemes, though
usually to a lesser extent). Moreover, Parliament envisaged the
possibility of compensation being adjusted. Levers embedded in the
Act allow compensation to be increased less quickly or even
reduced, were this needed to balance the books. That exposure to
downside risk arguably gives beneficiaries some claim to the
upside.
However, the PPF consistently viewed changes to compensation as
a last resort, with the levy being the first lever to pull if more
resources were needed – and would be likely to take the same
approach if it needed to rebuild its reserves in future. Levy
payers may, therefore, feel entitled to at least the bulk of any
surplus that is ultimately distributed – which seems
‘fair’ if one considers the levy to be a form of insurance
premium that those who have paid (under a mandatory
‘contract’) have, in effect, overpaid.
Conclusion
There is an old joke about someone asking for directions and
being told “I wouldn’t start from here” and it would
have been preferable for ownership of PPF surplus to have been
settled much earlier. Levy payers have the strongest claim but can
expect the case for beneficiaries to be pressed strongly. Both
groups may fear that the complexity involved in making payments to
them will encourage policymakers to favour other less justifiable
options.
Footnotes
1 A decision would be needed as to whether this applies
to existing members or just members admitted after a particular
future date.
2 As mooted in “Options for Defined Benefit schemes: a call for
evidence“.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
