If you’re paying into a company pension scheme (or if you have funds accrued in a company scheme sponsored by a previous employer), the high profile corporate insolvencies that have hit the headlines over the last couple of years may have caused you the odd moment of concern.
“What would happen to my pension,” you may have wondered, “if the company I work or worked for were to go under?”
If you’ve been through precisely this moment of hypothetical panic, you will probably have been reassured by reading about the PPF, the Government backed Pension Protection Fund, which looks after the interests of members of pension schemes associated with companies which become insolvent.
“Phew!” you could be forgiven for having thought. “There’s a safety net in place. Even the poor members of the BHS scheme are being looked after by the PPF… so whatever happened to any company whose scheme I’m in, I’d be fine.”
Now thinking about the unthinkable is never comfortable.
Serious illness is uncomfortable to consider, and its striking may seem like a small risk. Yet it’s important to look properly at the measures you have in place should you be unlucky, and to make sure these are as effective as they could possibly be.
In just the same way, the idea of a scheme sponsor’s insolvency wreaking havoc on your pension may be unattractive, and may seem unlikely. But as pension advisers, our view at PWS is that it’s every bit as important to review whether you’re happy with the level of safeguarding the PPF provides for your pension; or might you be able to decrease your personal exposure?
So, what exactly is the PPF?
“The PPF is a statutory fund created under the Pensions Act 2004”, explains our Private Client Adviser, Kareem Rathore. “It exists to provide compensation of benefits to members of defined benefit pension schemes where the company sponsoring the scheme becomes insolvent.”
In other words, if you have benefits in an employer scheme and that employer goes bust, the PPF is there to ensure you don’t lose your pension.
In general terms, it does a very good job, and it goes a long way to fulfilling part of the aim of setting it up, which was to build confidence in pension schemes amongst the public.
The PPF is funded by a levy charged annually to every defined benefit scheme whose members would be eligible to enter the scheme should the employer sponsoring that scheme become insolvent.
At the present time, 230,664 pension scheme members have been transferred into the PPF, with some 124,705 now receiving compensation. However, it’s worth noting that the average annual compensation per member currently amounts to just £4,291.86 per year.
High profile pension schemes to have entered the PPF include BHS, MG Rover Group, the KODAK Pension Plan, the Swissport UK Pension Scheme, British Midland Airways, Allied Carpets Group, The Jessop Group, Woolworths Group, the Royal Doulton Pension Plan and the HMV Group Pension Plan.
Would you still get your full benefits if your scheme entered the PPF?
If you were unfortunate enough to find that a scheme of which you were a member were suddenly entered into the PPF, would you be able to count on receiving the same benefits you’d have received from the scheme itself?
“In a word, no,” explains Kareem. “Firstly, if you’re still working and under retirement age, as soon as your fund goes into the PPF you will stop accruing benefits. However much your pension was worth at the point the scheme entered the PPF will still increase in line with inflation, but that’s it. Then, when you retire, the annual value of your pension will be capped at the level that has been set by the PPF. You will receive whichever is the lower of 90% of the actual annual value of your pension income, or 90% of the maximum annual income cap set by the PPF, currently £38,505.61 (£34,655.05 when the 90% level is applied).”
An article in The Telegraph on the pension panic that surrounded the collapse of BHS in 2016 included four excellent illustrations.
- CASE 1 – ‘Still working’ scheme member with sizeable pension
This imagined a 55 year old male employee of BHS whose pension was already worth £37,000 a year when BHS crashed. He’d planned to retire at 60, which had been the normal retirement age for the BHS scheme. Now the PPF cap level for a member retiring at 60 was £31,439 per annum. So the man would have stood to receive 90% of that sum, which is £28,295 a year. The important thing to notice, however, is that this is 24.5% less than he’d expected to receive from the BHS scheme.
- CASE 2 – ‘Still working’ scheme member with smaller pension
In this case, another male member of the BHS scheme, also aged 55, had a pension worth £15,000 a year. He would probably have been below the PPF cap level when he retired at age 60. He would be likely to receive 90pc of whatever his pension was actually worth at that time, which would be at least £13,500 a year. In his case, the entrance of the BHS scheme into the PPF would have cost him only 10% of his pension benefit, though of course this is still a substantial downgrade.
- CASE 3 – ‘Already retired at normal age’ scheme member
The third case looked at a 64-year-old female former BHS employee who had retired four years before the scheme entered the PPF, at the scheme’s normal pension age. She was drawing a pension of £45,000 a year until the collapse. She would not be capped, because in her case she was already past the normal pension age of her scheme. In line with PPF overall policy, however, only her earnings since 1997 would be index-linked. However much of her pension had been earned before that would not rise in future in line with inflation. But, essentially, she would otherwise experience no disadvantage as a result of the scheme entering the PPF.
- CASE 4 – ‘Already retired early’ scheme member
The last case looked at a 59 year old female former BHS employee who had retired at 55, 5 years earlier than the normal scheme age, with a pension of £40,000 a year. PPF rules cap anyone who retired early and is still under the scheme’s normal retirement age, at the level for the age they were when the scheme entered the PPF. So this woman would be capped at 90% of the scheme cap level for a 59 year old. This would reduce her income to £28,270 a year, which is a drop of 29.5%.
The effect of entering the PPF on scheme members.
In summary, should a scheme of which you are a member enter the PPF, there will almost always be some detrimental effect on the amount of pension you are able to draw.
This will be at a minimum if you were already retired before the scheme entered the PPF, and had worked to the scheme’s normal retirement age.
It’s likely to be most detrimental, however, if you are still working at the time the scheme enters the PPF, and your pension value is already above the PPF income cap level. The further above that level your pension value was, the harder hit, in percentage terms, you’re likely to be.
Inevitably, this means that individuals who were in more highly remunerated roles, or later in their careers, will generally be hardest hit.
Where PWS sees danger for the PPF.
As pensions advisers, we respect the job the PPF does in buoying confidence in pensions investment in general.
But we believe that the PPF is exposed to a number of risks that mean that for many of our clients, who have or are building up substantial pension savings, remaining in the scheme of a company that may one day have to move that scheme into the PPF is risky.
Firstly, there is something of a disturbing trend amongst troubled companies to place the pension scheme into the PPF as a way out of their pension obligations. This enables them to reduce the effect of their pension obligations while continuing to trade.
Monarch Airlines, which collapsed recently, is an excellent example of this, having moved its pension scheme into the PPF in 2015, while then continuing to operate.
The other risk, contributed to in part by this ‘tactical entry’, is that as more schemes enter the PPF the fund itself comes under increased pressure.
The PPF is funded by the annual levies from eligible but still properly functioning schemes. These are invested with the aim of creating returns in surfeit of the sum of the benefits the PPF needs to pay out to members. If more schemes enter the PPF, and so less levies are paid, this could tip the scale, causing the PPF to come under exactly the same strain that afflicted those employers that offloaded their schemes initially.
Were this to happen, the only way the PPF could withstand the pressure would be to consider reducing benefits further, beyond its current capping levels.
PWS advice on this to our pension clients.
“In light of the levels of pensions savings frequently held by our clients, and the challenges faced by the PPF,” says Kareem Rathore, “we believe it’s important that the liabilities of all schemes of which you are a member, and the potential PPF compensation you would receive should one of these schemes fail, be considered during any responsible review of your pension options.”
Talk to your Client Adviser. If you are not a PWS client at this time, contact us and one of our Advisers will be pleased to explore this further with you.