Introduction
In August 2010 the PPF publicised its intention to be self-sufficient (ie not to require further levy payments) by 2030. Therefore, its plans for the levy in the meantime take this target into account.
It has published proposals that are aimed at ensuring that the levy:
- reflects more appropriately the risk that individual schemes pose to the PPF and
- is more stable and predictable.
How the PPF proposes to change the levy formula
The key features of the proposed framework are:
- a formula that is fixed for a 3-year period, so that a scheme’s levy would change during this period only if its risk characteristics change,
- a new measure of funding that uses market movements averaged over 5 years, to reduce volatility,
- allowance for investment risk, to ensure that the levy reflects more accurately each scheme’s risk to the PPF,
- a narrower range of insolvency probabilities set in a way that is consistent with market measures and with the PPF’s claims experience to date,
- fewer insolvency bands, with measurement averaged over a year, making the levy less sensitive to short-term changes in employers’ D&B failure scores and
- the continuation of the policy of capping insolvency probabilities and the risk-based levy as a proportion of liabilities.
The new framework
To date the PPF has set a total levy that it wishes to collect each year and then set a scaling factor to apply to individual scheme levies to ensure that the total is met. This has meant that individual schemes’ levies have been affected by the risk profiles of other schemes. It has also produced a régime where, if every scheme introduces risk-reduction measures, the scaling factor rises to avoid levies falling: not a régime designed to encourage responsible behaviour! Going forward the PPF intends to fix:
- the scaling factor,
- the levy caps (as a % of the protected liabilities) and
- the proportion of the levy that is scheme-based –
for 3 years at a time and for the total levy collected each year to be the sum of the individual levies. However, the PPF would retain the right to revise the scaling factor during the 3 years if the total levy would otherwise be expected:
- to exceed the ceiling set by legislation,
- to vary from the previous year’s total by more than 25% in either direction or
- to result in the RBL comprising less than 80% of the total.
Every three years the PPF would review its funding needs in the light of its long-term funding strategy and set the level of the aggregate levies to be collected.
As now, the basic formula for calculating the risk-based levy (RBL) would be:
RBL = Underfunding Risk x Insolvency Risk x Fixed Scaling Factor
The PPF expects the scaling factor to be less than 1.0 under the new framework.
Investment Risk
Two schemes with the same funding level might pose different levels of risk to the PPF if they have different investment strategies. It is reasonable, therefore, that the levy should reflect the difference in risk. This is also expected to reduce the relative attraction of higher-risk assets for schemes with a weak employer covenant.
The PPF will measure investment risk by calculating the changes in funding level that would result from certain movements in different asset classes, such as a reduction in Bond yields (increasing liabilities) accompanied by a fall in Equity values. For this purpose they will use asset information submitted in the Scheme Return each year and liability information from the last section 179 valuation.
Schemes may certify their own calculation if they wish, based on their own more detailed information, and schemes with liabilities of more than £1.5 billion will be required to self-certify, reflecting the greater potential impact such schemes could have on the PPF.
What would be the impact on schemes?
The main effect of the proposed framework is to place a greater emphasis on funding risk, relative to insolvency risk. This should be advantageous, as schemes and sponsors have more control over funding risk and investment strategy.
PPF analysis suggests that, under these proposals:
- well-funded schemes can expect a reduction in their levy, regardless of the employers’ failure score, the reduction being larger for those schemes with the highest funding levels;
- less well-funded schemes whose employers fall into bands 4-6 may also expect a small reduction in their levy and
- less well-funded schemes whose employers fall into bands 1-3 may expect an increase in their levy, the increase being larger for those schemes with the lowest funding levels.
Schemes with mismatched investments, particularly larger holdings in Equities, are likely to see smaller reductions or greater increases.