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.
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".
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