Suzi Lowther, senior consultant at Punter Southall: It was announced in late September that the Pension Protection Fund (PPF) was about to start issuing levy invoices to defined benefit pension schemes for the 2007/8 year. The aim is to raise £675 million to help compensate the members of underfunded pensions with insolvent employers. However, not all finance directors are aware of how the levy on their invoice is calculated; what they can do if they disagree with it; nor how the levy might change in future.
The 2007/08 levy consists of ‘risk-based’ and ‘scheme-based’ components. The scheme-based component is calculated as 0.016% x PPF liabilities. The PPF liabilities are the scheme liabilities calculated on a prescribed basis with adjustments to take account of the level of compensation that would be paid if the scheme were transferred to the PPF.
The risk-based component is calculated as underfunding risk x insolvency risk x 80% x 2.47.
The ‘underfunding risk’ component of the formula is calculated as 105% x PPF liabilities – scheme assets. Schemes with assets greater than 125% PPF liabilities pay no risk-based levy and there is a tapering amount for schemes with assets between 104% and 125% of liabilities.
The ‘insolvency risk’ part of the formula is measured by the ‘failure score’ given to every company sponsoring a pension scheme by credit rating firm Dun and Bradstreet (D&B).
There is an overall cap on the risk-based levy that a scheme can pay each year. In 2007/08 this is 1.25% of section 179 liabilities. The 2.47 figure in the formula is a ‘scaling factor’ and can change each year. In 2006/07 the scaling factor was 0.53 meaning schemes whose deficit and insolvency rating had remained unchanged since the last year would have seen a near five-fold increase in the risk-based levy.
If a finance director needs to appeal an invoice, the PPF encourages schemes to raise informal enquiries at first. If there is a genuine error in the invoice, it should be settled at this stage. The enquiry must be made within 28 days of the date of the invoice. Concerns with the D&B failure score must be raised directly with D&B, also within a 28 day window.
Where the informal route has failed, the PPF has a formal appeals process. However, the scope of this is very restricted – the PPF is only required to review the actual calculation itself, not the underlying principles.
There are likely to be changes to the way the levy is calculated in the future. In August 2007, the Board of the PPF issued a consultation paper on proposals for the future of the levy from 2008/09 onwards, based around ensuring greater stability and certainty.
One key proposal is that the data used to calculate each year’s levy should be assessed a whole year in advance of the start of the levy year. For the 2007/8 levy year, schemes could not predict their levy accurately until the end of April 2007. Under the proposals, schemes would know how much their 2009/10 levy would be by November 2008. The PPF recently indicated that it will consider allowing deficit reduction contributions paid after the measurement date to be taken into account in the levy calculation.
The consultation also proposes that the cut-off points at which schemes face reduced risk-based levy (the 104% and 125% levels indicated above) are shifted upwards. This means better funded schemes would probably face higher levies in future.
The paper also looks at the longer term shape of the levy and whether the model should be adjusted to take account of catastrophic events.
D&B have also made significant changes to their methodology. Many organisations can expect to see their failure score for the 2008/9 levy year fall significantly. However, the associated insolvency probabilities have also been revised so the same insolvency probability is likely to be associated with a much lower failure score. For example, an insolvency probability of 0.0065 corresponds to a ‘new’ failure score of 60 but an ‘old’ failure score of 87. These changes make it even more important that employers monitor their failure score on a regular basis and in particular check the associated insolvency probability.
We are expecting the PPF to issue their response to the consultation on their proposed changes in November. So, as you pay your 2007/8 levy invoice, look out for the changes for 2008/9 and future years.
- Suzi Lowther is a senior consultant at Punter Southall