The opdu Report - Issue 22, May 2007

Bulletin Board
The Pension Protection Fund – Two Years On
Lawrence Churchill, Chairman Pension Protection Fund

On April 6th 2005, the original twelve staff of the Pension Protection Fund stood in an empty office space tasked with providing protection to those who have suffered the cruellest of fates: the ruin of their retirement plans due to the financial difficulties of the employer sponsoring their pension scheme. In our first week of operation, our raison d’etre was given added significance as we watched the collapse of MG Rover on the national news, casting into doubt over 6000 futures. This tragic problem is not uncommon. Since that day in 2005 almost 150 schemes, representing 100,000 scheme members, have entered our assessment process. These members will now receive at least Pension Protection Fund levels of benefits.

Progress

Even before we opened for business, many people said that it wouldn’t work, that the Pension Protection Fund would prove to be both omen and agent of the demise of defined benefit pensions in the UK. Two years later, we’re up and running and we’re doing our job, working to protect pensions in a number of areas.

One of the most difficult challenges we faced was the pension protection levy. We were given five years to introduce the risk based part of the levy, bearing in mind that a system of this kind has never been attempted before anywhere else in the world – even among the six foreign pension protection organisations. We were extremely proud to be able to implement the levy after just one year, the shortest timeframe allowed by the Pensions Act 2004. We considered it essential to take up our powers and responsibilities in full at the earliest possible opportunity in order to provide much-needed stability for defined benefit pensions in the UK.

Of course, the levy is a charge on businesses and pensions schemes and the task of gaining acceptance for it among our stakeholders is ongoing. We’re committed to communicating with the industry and we’ve consulted on the design and the estimated figure of both pension protection levies so far. We’ll also be undertaking a major review of the levy system later this year and we’ll be keen to hear stakeholders’ views. We’re building a Pension Protection Fund culture of credibility, competency, consideration and communication, and our consultation exercises are an extremely important part of this process.

While we want to hear your views on our work, we are keen to share our own thoughts with you. The Pensions Universe Risk Profile (Purple) Book, which we published in December in conjunction with the Pensions Regulator, is a significant information resource for the UK defined benefit pension system. When the PPF was formed the state of defined benefit pensions in the UK wasn’t known. Now the Purple Book will provide information for the industry as well as acting as a resource to inform our own decisions. Sharing this research with our stakeholders is one way we can demonstrate our commitment to transparency in our actions.

Last October, we updated our Statement of Investment Principles which outlines our liability driven investment strategy. Our recent appointment of five new fund managers to manage a portfolio which we expect to be worth more than £5 billion by 2009 is proof of our financial muscle, particularly when set against the £300 million raised by the pension protection levy in 2006/07. As our investment fund grows, the returns it generates will outstrip the income we raise through the levy. Of course, we need to ensure that we protect ourselves against the financial risks to which the private sector pensions industry is exposed, so that we can continue to take on schemes in the event of an economic downturn. We’ve done this with the kind of financial innovation found in the private sector.

While these measures are providing value for the industry, that raison d’etre of protection is primarily for scheme members. Therefore, our greatest achievement to date is that we’re providing compensation for over 1,300 pension scheme members today, with over 5,500 deferred members waiting to reach their scheme’s normal retirement age and subsequently receive their compensation

The milestone of our first compensation payments in December was recently followed by a second group of scheme transfers into the Pension Protection Fund.
The biggest of these was the MG Rover Group pension scheme with over 6,000 members. All of the 13 schemes which have come through our assessment period have done so in less than 20 months, well ahead of our two year target. This is a major achievement and proof that we are developing a system for scheme transfers which delivers security and builds confidence. More importantly, those scheme members can look forward to a secure environment with a safe income. At the end of March Robert Lealand, one of the members of the MG Rover scheme, said

“To have invested in my pension for 26 years and lost it all would have been a huge blow. We were very lucky that the Pension Protection Fund was set up; I now receive much more than I would have got if the PPF did not exist.”

To have helped in realising the value of over 6000 futures is a tremendous achievement for the pensions industry. As we expect another 65 schemes to transfer into the PPF over the next year, it is also an achievement that will be built upon quickly as we move forward.

Improvements at the PPF

Although we’re very proud of these achievements, there is still a lot to be done and we’re not about to start taking it easy. Despite the progress made with Purple, there are still significant holes in the data available for pension schemes. Filling these, with the help of the Regulator’s scheme returns, will make our levy system more efficient.

We’re also refining the way we work with D&B. We’ve customised the insolvency failure score to make it more stable and representative when it comes to levy calculations.

How can we help improve the Industry?

The levy review I mentioned above will include a close look at the distribution of the risk based levy in terms of the levy cap and the cross subsidy effect. We also need to ensure that the levy continues to perform against our objective of proportionality – distribution must be consistent with the risk posed to us
We’ll also be examining our solvency position with some scrutiny as the steady flow of scheme transfers begins.

Innovation in the industry

We’re not the only ones who’ve been making progress; the past two years have been dominated by a spirit of innovation in the industry and new ideas and products are being developed with gathering pace. There have been new strategies for investment, novel ways of providing security via contingent assets, movements toward a market for trading mortality risk and new approaches to pension scheme design – risk sharing looks essential, but which models are the best trade-offs?

We embrace these cutting edge ideas as catalysts for change in defined benefit pensions, reducing risk and building security for scheme members, and we’re pleased to be working with the industry at this exciting time. For our part, we’re innovating to build a strong balance sheet with all the tools open to financial institutions. We’re here for the long run, to build on our success and continue to pay the right compensation to the right people at the right time.

Schemes and Scheme Members enjoying the benefits of PPF protection:

As at 31 March 2006 Source: PPF Annual Report and Accounts 2005/06

Lawrence Churchill Chairman,
Pension Protection Fund
0845 600 2541
information@ppf.gsi.gov.uk
www.pensionprotectionfund.org.uk