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FAQs: Pension Protection Levy 2006/07

General Questions

When is the risk based levy being introduced, what is it and how will it be calculated? (updated 23/5/06)
The risk based levy will be introduced for all eligible schemes from April 2006 to cover the 2006/07 financial year. The levy will be calculated by multiplying a scheme’s underfunding risk by its insolvency risk to determine the scheme’s risk exposure. The Board will then multiply each scheme’s risk exposure by 0.8 (because the levy is 80% risk based), and by a levy scaling factor of 0.53, to determine how much levy each scheme will have to pay. This will help ensure that the Board collects the overall amount it considers should be raised (its levy estimate). The formula for the risk based levy will be:

RBL = U x P x 0.8 x 0.53
RBL = risk based levy
U = underfunding risk
P = assumed insolvency probability
0.8 = percentage of the levy that is risk-based

What is the scheme based levy, and how will it be calculated?
The scheme based levy will be paid by all schemes on the basis of their size, to recognise that all schemes pose some risk to the Pension Protection Fund. The scheme based levy will make up 20% of the total pension protection levy, and will be based on the amount of a scheme’s Pension Protection Fund liabilities. The formula for the scheme based levy will be:

SBL= L x M  
L = the scheme’s Pension Protection Fund liabilities, and
M = the multiplier, which will be 0.014% for levy year 2006/7



Contingent Assets

What is a contingent asset? And what contingent assets will the Board recognise for the 2006/07 risk based levy calculation? (added 28 February 2006)
A contingent asset is an asset that will produce cash for a pension scheme contingent on an insolvency event occurring to the sponsoring employer. For the 2006/07 risk based levy calculation the Board will take account of: inter-company guarantees from any group company or other associate of a participating employer, domiciled in an OECD country; security over cash; security over securities; and security over real estate in Scotland, England, Wales or Northern Ireland provided by any group company or other associate of a participating employer; and letters of credit and guarantees provided by banks and insurance companies with an AA-/Aa3 credit rating, domiciled in an OECD country.

Why will the Board only recognise standardised contingent assets? (updated 23 May 2006)
For the 2006/07 levy calculation, the Board will only recognise contingent asset arrangements that have been established using standardised forms of documentation.  This will reduce the enforceability risk to and the administrative burden for the Pension Protection Fund (and hence the administration levy). Trustees (or a person authorised by them) were asked to certify that the contingent assets for which they sought credit are in the standard form and are legally valid, binding and enforceable. The trustees were also required to obtain a legal opinion to satisfy themselves that this is the case. Consistent with this approach, the limited number of schemes which already had similar arrangements in place were required to move to the Pension Protection Fund’s standard form of documentation in order to obtain recognition for those arrangements within the risk based levy calculation.

In relation to Type A and Type B contingent assets, are changes to the definition of "Guaranteed Obligations" or “Secured Liabilities” – i.e. the cap on recovery by the trustees – permissible? (updated 13 March 2006)
No.  These caps have been formulated so as to ensure that the Board can always value contingent assets in the standard form in a fair and consistent way.  The value attributed to such assets, dependent on the form of the cap, is set out in Appendix 4 to the Board’s determination under section 175(5) of the Pensions Act 2004.  In practice the Board believes that the three choices of cap as set out within the Guaranteed Obligations/Secured Liabilities definitions should meet the needs of most schemes.  However the Board will consider adding further permutations in future levy years.

We put in place a Type B contingent asset.  However, the charge was not registered at all relevant registries by 31 March 2006. Can this asset still be taken into account in the 2006/07 risk based levy calculation? (updated 23 May 2006)
As noted elsewhere in the guidance and FAQs, the deadline for submission of all voluntary forms – including certificates in respect of contingent assets – was 31 March 2006.  The certificates in respect of Type B contingent assets required the trustees (or a person authorised by them) to confirm, amongst other things, that the security had been properly registered as required by the relevant legislation.

However, the Board recognises that there may in practice have been a delay between the delivery of documentation to the relevant registry and the actual registration of the security, and that this is outside the control of the trustees and other involved parties.  Moreover, it is standard practice in the secured lending market for banks to make advances against secured assets before the registration formalities have been completed.  Accordingly, although the final form documentation has been available to trustees and advisers for use since 24 January, the Board will permit the following relaxation of the deadline for registration of charges.

The Board will recognise a Type B contingent asset for the 2006-7 levy year provided that all filings required by the relevant legislation have been properly made before the expiry of the relevant priority periods and statutory deadlines and in any event no later than 31 March 2006.  Trustees must have still provided the electronic certificate to the Board no later than 31 March, which required them to certify that the documentation has been properly registered.  However where in fact the documents have been filed within the relevant priority periods, but are awaiting registration, the trustees should have included a note to that effect in the hard copy additional documentation which must also have been supplied to the Board by  31 March 2006.  The legal opinion provided in support of the documentation may where necessary also have been qualified in so far as any of the elements of the opinion are dependent on actual registration.

Trustees and their advisers should, of course, ensure that registration does occur as quickly as possible, and deal with any queries raised by the relevant registries in a timely fashion.  If the security has still not been successfully registered in all relevant registries by 30 June 2006 the trustees must notify the Board and in such circumstances the Board reserves the right to withdraw the risk based levy credit given in respect of the Type B contingent asset.

Please note that this relaxation applies only to filings at the relevant companies and land registries, and will only be permitted to the extent trustees and their advisers comply with the alternative requirements set out above.  No other deadlines or rules are affected in any way.

Will the Board give levy credit for more than one Type A group company guarantee in respect of the same scheme? (updated 23 May 2006)

Yes. Provided each such guarantee satisfies all of the Board's requirements for a Type A contingent asset, and the Board received all relevant certification and documentation in respect of this asset by 31 March of the respective year, then it will be eligible to be taken into account in the risk based levy calculation for that scheme, and will be treated in a manner consistent with the approach taken to single Type A contingent assets. The Board has published a brief note explaining how the formulae set out in paragraphs 12 and 13 of Appendix 4 to the levy determination will be extended where there is more than one Type A contingent asset, which may be accessed by clicking here. Trustees (or a person authorised by them) should have submitted a separate certificate in respect of each such contingent asset, as well as supplying all required hard copy documentation, by the annual deadline.

We have put a Type A guarantee in place, under which Company A guarantees the obligations of employer B.  However, we have now obtained the 31 March D&B Failure Scores for these two companies and have discovered that the assumed insolvency probability of A is actually higher than that of B. How will the risk based levy now be calculated for this scheme? (updated 23 May 2006)

For the purposes of the risk based levy for 2006-7, the Board will look at the assumed insolvency probabilities (based on D&B data) for A and B on 31 March 2006.  If on that date the insolvency probability of B is higher than that of A, then the guarantee will be taken into account and will result in a reduction in the levy in accordance with the formulae set out in the levy determination.  If, however, on that date the insolvency probability of the guarantor A is actually higher than that of employer B, then the guarantee will be ignored for the purposes of the levy.

Because the insolvency probabilities are taken as a “snapshot” as at 31 March 2006, changes to the relative insolvency probabilities of the guarantor and employer over the course of the levy year will not in themselves have any effect on the levy.  However, if the guarantor is in financial difficulties it may have to make certain notifications under the terms of the guarantee.

For future levy years, it is anticipated that the Board will look at the insolvency probabilities of the guarantor and the employer on the 31 March immediately preceding that year.  If the guarantor’s insolvency probability is higher than that of the employer at that point, then the guarantee will similarly be ignored for the levy for that year.  Hence it would be possible for the same guarantee to be taken into account for levy purposes in some years and not others.  It should be noted that the precise rules for calculating the risk based levy in future years will depend on the Board’s determination of the levy for each year.




Underfunding

How do I access the MSCI World (gross) Total Return Index referred to in the formuale for converting MFR valuations to section 179 basis?
The MSCI World (gross) Total Return Index is available from the MSCI website. From the homepage, click on 'Equity Indices' in the left hand column, and then 'The World Index' in the table. At this point, a first time user needs to register before logging in. Once through the login screen, select 'Gross Index (USD)' in the Index Type box and then enter the desired start and end dates before clicking 'download'. These USD rates will need to be converted into GBP using appropriate exchange rates.

On the most recent MFR valuation, I gave no further information than that the scheme was more than 120% funded on an MFR basis, how will the PPF estimate s179 liabilities from this information?
If the only information available about a scheme’s funding position was that at the most recent valuation the MFR funding level exceeded 120%, the Pension Protection Fund Board would:

(a) Assume an MFR funding level of 125%
(b) Use the asset figure and (a) to calculate total liabilities.
(c) Assume an average split of MFR liabilities for the date of the valuation – 45% pensioner; 25% deferred; 30% active.
(d) Adjust the MFR liabilities to approximate to s179 liabilities in the same way as for other schemes.

On the most recent MFR valuation, I gave no further information than that the scheme was more than 120% funded on an MFR basis, how will the PPF estimate s179 liabilities from this information? (updated 16/1/06)
If the only information available about a scheme’s funding position was that at the most recent valuation the MFR funding level exceeded 120%, the Pension Protection Fund Board would:

Do you intend to publish information on the assumed average ages to be used by the PPF to calculate the levy where this information has not been supplied?
No. We do not envisage publishing information on the assumed average ages used where this data is absent

How will the PPF derive the Minimum Funding Requirement pension increase assumptions where the increases are, for example, inflation limited to 5% but subject to a minimum of 3%, or fixed pension increases? (updated 13/3/06)
The methodology is an approximate calculation and one of the simplifying assumptions is that increases to pension in payment in respect of benefits accrued after 5 April 1997 are taken to be Limited Price Indexation (i.e. pensions increased by inflation or 5% if lower). Guidance Note 27 issued by the Institute of Actuaries and the Faculty of Actuaries specifies the MFR assumption for LPI increases.

Another simplifying assumption is to assume the pension increases on all benefits accrued before 6 April 1997 are the increases disclosed on the Scheme Return issued by the Pensions Regulator. This allows a scheme to declare it has fixed pension increases, pension increases of a percentage of RPI, inflation subject to a cap, or an “other” definition of pension increases.

At the end of MFR transformation formulae in the levy consultation update there are tables showing how the MFR pension increase assumptions will be determined in certain cases. These tables are intended to give an indication of the approach that will be adopted, although they are not fully comprehensive. The Board does not currently intend to provide a fully comprehensive set of tables in view of the great variety of pension increases used by eligible pension schemes.

The Board intends to adopt a prudent assumption for all schemes which have indicated “other” pension increases. The Board does not propose to publish information on the assumption used in this circumstance.  Assuming that they were shown as having “other” pension increases on the basis that the other categories on the scheme return do not directly reflect the benefit definition, schemes with pension increases of LPI subject to a minimum of 3% will have this assumption applied to them.

In section (a)(VI) of the methodology, the assumptions for defannuityfactor(MFRrate@MFRDate) in the formulae for S179PLEqEasePre97 and S179PLEqEasePost97 (these variables concerning the part of pensioner liabilities the MFR deems to be equity related, in accordance with the MFR equity easement) say to follow the guidance in GN27 Appendix 2 paragraph A. But the summary of factors for the MFR basis at the end of the methodology document say “for the ‘equity easement’ component use … 1.1 and 10%” which are from GN27 Appendix 2 paragraph B1. Should these two references in (a)(VI) be to GN27 Appendix 2 B1, and not A?
Yes.

In section (c)(I) of the methodology, annuityfactor2 and annuityfactor4 are said to be the same as two annuityfactors in (a)(VI). However (a)(VI) contains both “standard” annuities based on MFR or S179 mortality assumptions and annuity certains based on fixed terms if the equity easement applies to the scheme. Which annuityfactors should be used?
Refer to the “standard” annuities in (a)(VI) for calculating annuityfactors 2 and 4 in (c)(I), i.e. those using mortality assumptions and not the annuity certains.

The methodology also comments that because these annuities are the same they are not critical to the eventual result of the calculation. We acknowledge that although this comment applies where the equity easement is not allowed for (i.e. when M=0, see (a)(IV) for definition of M) because the numerator annuities in (a)(VI) cancel out with those in the denominators in (c)(I), the annuities do not cancel out if the equity easement is allowed for (when M>0).

What does the PPF propose to do where a scheme has more than one level of pre 1997 pension increase? Examples could be (1) different increases depending on level of membership (say, directors and employees), and (2) different increases attributable to different periods of pre 1997 service. (added 18/1/06)
Only one level of pre 1997 pension increase is allowed for in the MFR conversion formulae.  Where schemes have provided more than one level of pension increase in their scheme return it is likely that the information that we receive from the Pensions Regulator will not be useable. If this is the case then the PPF Board will make a prudent assumption about the level of pre 1997 pension increase. We do not propose to publish information on the assumptions used under these circumstances.

If the scheme return shows a specific percentage above 120% will you use it notwithstanding there is no requirement to have submitted the data? (added 20/1/06)
If a scheme return shows a specific percentage above 120%, then we will use it notwithstanding that there is no requirement to have submitted the data.

If a scheme submits a Section 179 valuation before the 31 March 2006 deadline, will the scheme’s levy be calculated using the lower of its actual Section 179 liabilities and those estimated from the scheme’s MFR valuation? (added 6/2/06)
No. The PPF will only calculate a scheme’s 2006/07 levy with reference to its MFR valuation if a Section 179 valuation has not been received by 31 March 2006.

Are the year of use (“U”) mortality tables for the annuity factors in section c(I) of the MFR Transformation Methodology year of birth tables? (added 14/2/06)
Yes.

For annuityfactors 1 to 4, which are for calculations concerning pensioners, year of use 2005 means a year of birth table based on the average age and a date of calculation of 2005. For example, if the average age of pensioners were 65 then the mortality table to use for annuityfactors 1 to 4 would be PMA92mcB1940.

An annuity factor calculated at age 63 is part of defannuityfactors 1 to 8. The mortality table is shown as PMA92mc (U=2005 + 63 – average age), so for example an average age of 43 would give U=2025. For an age 63 annuity this corresponds to year of birth 1962, which is the same as the year of birth mortality table for someone aged 43 in 2005.

Is the “FTSE-UK gilt TRI” index referred to in section (b)(II) of the formulae the All Stocks index? (added 13/3/2006)
Yes, it is the FTSE Actuaries Government Securities UK Gilts All Stocks Total Return index.

The scheme I am working on has a gilts-matching policy and the MFR liabilities on the scheme return were calculated using a gilts-matching basis. Can I update the scheme return data to show “equity-based” MFR liabilities? If not will the MFR transformation formulae be adjusted to allow for gilts-matching MFR calculations? (added 13/3/2006)
No and no. The MFR transformation formulae are an approximation which is closer for some schemes than others. We understand that the MFR valuation results asked for on the scheme return are the gilts-matching MFR results where the gilts-matching basis was used for that MFR valuation. If no section 179 valuation is supplied to the Board by 31 March 2006, then for the 2006/07 levy the MFR transformation formulae will be applied to the scheme return data as shown; no additional adjustments in respect of MFR gilts-matching will be made.

What guarantee periods should be assumed for the annuities in the MFR transformation formulae? (added 22/3/06)
Guarantee periods should be ignored for all annuities in the MFR transformation formulae.

In the summary of discount rates for the marked-to-market MFR basis for pensioners in the MFR Transformation Formulae, the discount rate for pension increases of “Fixed at p% a year” is shown as “Annualised … 15-year Yield” / (1+ p%). Does this mean [ (1 + Y%) / (1 + p%) ] – 1 ? (added 24/3/06)
Yes, in common with the assumption that would be used for a MFR valuation of such benefits.




Insolvency Risk

What is the latest date that an employer can make changes to improve its failure score and be sure that the insolvency risk used to calculate the risk based levy for the year commencing 1 April 2006 is updated to reflect these changes?
The Board of the Pension Protection Fund proposes to take a snapshot of the failure scores of the participating employers of all eligible schemes on 31 March 2006, any changes to the position of a sponsoring company would have to be made in sufficient time to be reflected in the risk assessed by D&B at that date. You should contact D&B customer services on 0870 2432344 for further information on how long it would take for a particular change to take effect on the D&B failure score.

My D&B failure score does not correspond to the credit rating from Moody’s/S&P/Fitch etc, why won’t the PPF take my credit rating instead?
The Board has appointed D&B as their sole insolvency risk provider, as they consider D&B’s to be a leading provider of global business information, with a proven track record and a scoring methodology is already viewed as credible by the industry.

A number of consultation responses considered that the Board should use a company’s credit rating instead of its failure score if a credit rating was available.

The Board carefully considered the different approaches to measuring insolvency risk including credit scoring, and credit rating methods. They concluded that D&Bs credit scoring method provides a sound quantitative assessment of risk.

The Board is also aware that credit rating agencies usually measure default rather than insolvency risk. It is an insolvency event that will trigger the PPF assessment period and therefore risk of insolvency that the Board is required by legislation to consider. Although default is often a pre-cursor to insolvency, an insolvency event does not always follow a company defaulting. By using the probability of default the PPF could be over estimating the amount of levy needed to be collected.

Similarly, the Board is concerned that available credit ratings might not necessarily assess the sponsoring employer, which is this specific entity that the Board is required to consider.

What about intangible assets?
The D&B failure score is based on past experience of actual company insolvencies. The statistical models which sit behind the ratings are based on a sound, tried and tested mathematical approach, which has been tailored to maximise the accuracy of predicting future financial events.

In accurately reflecting past experience of actual company insolvency D&B does not consider the inclusion of intangible assets in balance sheet information to be an accurate tool for predicting company insolvency. D&B considers that tangible net worth is a more accurate means by which to predict insolvency.

The Board has however given careful consideration to the current D&B policy which caps a failure score of a business with negative net worth.

The modelling work undertaken by the Pension Protection Fund to date has identified a disproportionately high number of companies who are subject to this rule within the universe of sponsoring employers of defined benefit schemes. The Board, in consultation with D&B, considers that this particular rule is not appropriate for calculating insolvency risk as part of the risk based levy calculation.

The Board of the Pension Protection Fund has therefore decided to ignore this rule for the purposes of the 2006/07 risk based levy calculation.

Will the Board still need a generic risk band as suggested in the July Consultation Document, and if so, how will it be calculated?
For any employers for which a D&B failure score cannot be obtained the Board will use the average failure score for the UK sponsoring employers of defined benefit pension schemes within the relevant industry.

In order to define industry groups, the Board will use the first two digits of the 1972 Standard Industry Classification (SIC) codes, except for any three digit 1972 SIC codes where the first digit, which in practice should be preceded by a 0, will be used.

However, given that D&B is able to cover the vast majority of UK businesses, such cases are likely to be extremely rare.

By when should all information updates have been completed and registered with the relevant public authority to be taken into account in the snapshot of D&B Failure Scores taken on 31st March 2006? (added 17/1/06)

To calculate scheme insolvency risk, the Board will take a snapshot of the Failure Scores of the sponsoring employers of all eligible pension schemes on 31 March 2006. To be taken into account in that snapshot, any information that could potentially change the Failure Score should be registered with the relevant public authority in the appropriate way by 1 March 2006.

For example, audited accounts should be submitted to Companies’ House by 1 March 2006. Similarly, all County Court Judgements should have been cleared with the County Court concerned by 1 March.

I am aware that the D&B Failure Score methodology contains a Parent Severe Risk override which reduces the score of a subsidiary. How does the Pension Protection Fund propose to consider this rule for the 2006/07 levy calculation? (added 13/2/06)
The D&B Failure Score is based on past experience of actual company insolvencies. The statistical models which sit behind the ratings are based on a sound, tried and tested mathematical approach, which considers corporate linkage in its assessment. This has been tailored to maximise the accuracy of predicting future insolvency events.

The Board has given careful consideration to the current D&B methodology to apply a Parent Severe Risk override to the failure score of the subsidiary businesses of a parent company in severe risk and considers that this particular rule is not appropriate as part of the risk based levy calculation.

The Board of the Pension Protection Fund has therefore decided to ignore this rule for the purposes of the 2006/07 risk based levy calculation




Multi-employer schemes

What is the Pension Protection Fund’s definition of a sectionalised/segregated scheme? (added 20/3/06)
Pension Protection Fund legislation refers to segregated schemes which are defined as follows by regulation 1(2) of the Pension Protection Fund (Multi-employer Schemes) (Modification) Regulations 2005:

“”segregated scheme” means a multi-employer scheme which is divided into two or more sections where -

(a) any contributions payable to the scheme by an employer in relation to the scheme or by a member are allocated to that employer’s or that member’s section; and

(b)     a specified proportion of the assets of the scheme is attributable to each section of the scheme and cannot be used for the purposes of any other section.”

Such schemes are commonly referred to as sectionalised schemes, so both terms are used in these FAQs, to ensure all relevant schemes are aware that these FAQs apply to them.

What information will be required in respect of sectionalised/segregated eligible schemes and when will it be required by? Is there an extension to the 31/3/06 and 7/4/06 deadlines for submitting additional voluntary information in respect of such schemes? (updated 23/5/06)

The process that we will follow for collecting data in respect of sectionalised/segregated schemes will be a two-part process, as follows:

(1) The first part of the process will involve providing sectionalised/segregated schemes with an adapted scheme structure form. This form will be specific to sectionalised/segregated schemes and therefore differ from the voluntary form already available on our website. This form is called the Sectionalised Scheme Parent Form (referred to below simply as the parent form) and will request information on the number of sections within the scheme and each section’s name. We have now issued these parent forms to sectionalised/segregated and request that it is completed and submitted to us by the end of April.

(2) Once we have received a completed parent form back from a scheme we will progress to the second part of the process. This will involve providing the scheme with the required number of Sectionalised Scheme Child Forms (referred to below simply as child forms). One child form will be provided per section of the scheme. Before issuing these child forms we will pre-populate them with each section’s name and any further details that we are aware of for that section. The child forms will request employer data, valuation data and membership data in respect of each section.

We intend to allow eight weeks for schemes to provide us with the information requested in the parent and child forms. We aim to start issuing the child forms (on receipt of completed parent forms) by the end of April 2006.   It is likely that it may take us a few days to issue child forms following receipt of a completed parent form and we will consider whether we need to offer extra time to complete the child forms in such cases on a scheme by scheme basis.

There is no extension to the deadline for submitting additional voluntary information for sectionalised/segregated schemes. Within the 2006/07 pension protection levy calculation, the Board will only take account of additional voluntary information received by the 31/3/06 and 7/4/06 deadlines. Any additional voluntary provided should have been consistent with the information that you will be providing to us as part of the process described above during April and May 2006.  For example, an actuarial certificate of deficit reduction contributions should relate to deficit reduction contributions made between the date of the MFR/s179 valuation that will be provided on the child form, and the last day of the month before the date of the certificate
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