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PPF levy to include investment risk measure

The Pension Protection Fund (PPF) has unveiled changes to its new levy framework to take effect from 2012/13.

The proposals include a measure of schemes’ investment risk for the first time, the ‘smoothing’ of funding levels to remove short-term volatility from the calculation of underfunding risk and an increase in the number of insolvency rating bands from six to ten.

PPF chief executive, Alan Rubenstein, said: "We have worked closely with all our stakeholders in industry and elsewhere and we are grateful to everyone for their contributions.

The PPF said the investment risk element would require no additional reporting requirement for the majority of schemes. Instead it would apply a stress test to the asset and liability values currently submitted to The Pensions Regulator to calculate the stressed funding position.

For schemes with s179 liabilities of £1.5bn or more, the PPF said that a bespoke stress test of their assets would be required and results reported to the PPF in the annual scheme return.

The bespoke calculation covers two stages. The first applies a fuller list of stresses to capture more detailed investment information such as the different durations of fixed income products.

The second stage applies to schemes with investments in derivatives, either directly or through a pooled LDI fund, so that the risk-reducing qualities of these investments are reflected in the bespoke stress.

The PPF said that smaller schemes would still have the option to undertake the bespoke analysis if desired.

Commenting on the proposals, Mercer welcomed the changes but pointed out that the calculation of the levy could have profoundly negative financial implications for schemes when sponsoring companies are moved into a lower levy band - so called ‘cliff edge case’ companies.

Mike Fenton, principal at Mercer and PPF specialist, said "Overall, we agree with the direction of travel taken by the PPF’s new levy policy. However, if the new regime had been implemented this year, the PPF has estimated that 60% of schemes would have seen their levy increase and 10% would have seen it double.

"Since the changes also mean that most schemes with strong employers will see proportionately bigger levy increases, it’s likely that the levy will become financially significant to a larger proportion of the PPF’s stakeholders."

While the PPF has stated that more details will be published in the autumn, Mercer says that is advising trustees and companies to monitor their D&B scores to ensure they are as high as possible on the last working day of every month.

The PPF will continue to use data entered using the Pensions Regulator’s Exchange system to calculate the levy and, according to Mercer, it intends to continue to follow its existing policy of not permitting trustees to change data which proves to have been entered incorrectly.

Deborah Cooper, head of Mercer’s retirement research group, commented: "Eligible schemes have no alternative but to pay the levy to the PPF, so the PPF is like a tax-raising body. But if I make a mistake on my self assessment form this year, HMRC will let me correct it and reassess the tax I owe. The same is not true with the PPF. If a mistake results in a scheme paying a higher levy than it would have done based on correct data, the PPF will not necessarily refund the overpayment.

"The PPF has played an important role in bringing additional security to defined benefit pension scheme members but it should not be able to behave in such an arbitrary and unreasonable way to those it relies on to finance that security. It is about to launch a new regime for determining how scheme levies should be calculated - we suggest that, when it amends its determination to take the new levy formula into account, it also includes a new policy allowing trustees to correct data used to calculate their levy, following receipt of the levy invoice."

Full details of the levy framework can be found here. A further consultation on the calculation of the investment risk element is open until 24 June.