This week, the Pension Protection Fund ("PPF") confirmed its proposed levy policy for 2012/13 and beyond.   It is designed to mark a shift in emphasis from employer covenant towards scheme funding in the levy calculation, and to allow schemes and employers to benefit from a more transparent and stable levy bill. A pension scheme's risk-based levy will still be calculated by reference to underfunding multiplied by employer insolvency risk, but within that basic formula there are a number of innovations.

Core features of the new regime

The building blocks of the new approach are as follows:

  • the main levy parameters (the risk-based levy scaling factor, levy cap and scheme-based levy multiplier) will be fixed for 3 years, although there is a safety valve allowing the PPF to depart from this in certain circumstances
  • smoothing funding levels through a roll-forward mechanism, using a 5-year average, so that short-term market volatility is not reflected in the measurement of underfunding risk
  • reflecting investment risk by applying stresses to the asset and liability values on Exchange to calculate a stressed funding position for levy purposes
  • bespoke measurement of investment risk will be required from schemes with PPF liabilities of £1.5 billion or more, and will be optional for all other schemes
  • a new system of 10 insolvency rating bands for employers, instead of different calculations for each Dun & Bradstreet failure score from 1 to 100
  • averaging of employer failure scores over the last working day of each of the 12 months ending in March 2012 (meaning that D&B's monitoring process is effectively already underway).

Existing contingent assets will continue to be recognised, and schemes will still be able to obtain a levy reduction by setting up new such assets in the PPF's standard forms or by making and certifying deficit reduction contributions. The deadline for the submission and re-certification of contingent assets for levy year 2012/13 will remain the current PPF levy year end, i.e. Friday 30 March 2012.

Action points to consider

The immediate action point that arises is for scheme employers and "Type A" guarantors to monitor covenant strength more frequently for PPF levy purposes: it will no longer be effective to embark on a last-minute exercise to improve failure scores shortly before the March deadline.

Trustees and employers should also engage with their advisers to establish how the published approach to smoothing funding and stressing assets and liabilities may affect their scheme's 2012/13 levy calculation (and whether the scheme could benefit from exercising the new option of a bespoke investment risk calculation). The effect of proposed changes in scheme investment strategy on the levy should also be considered.

The PPF policy statement and annexes can be found here together with draft guidance for the calculation of bespoke investment risk (which the PPF is consulting on until 24 June).

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 18/05/2011.