As insolvencies ramp up and more defined benefit schemes are expected to end up at the Pension Protection Fund, the lifeboat fund could be forced to increase its levy, analysis from LCP has shown.
In a report published on Thursday (August 27), the consultancy considered the past 12 years of claims on the PPF since the global financial crisis, and modelled two scenarios for the coming years: “insolvencies double” and "deeper downturn".
"Insolvencies double" represents a £10bn hit that assumes a similar rate of insolvencies as followed the 2008 crash, but is based on more recent claim levels, while a “deeper downturn”, with a £20bn impact, reflects a slower recovery where PPF claims are focused on companies with larger deficits.
LCP warned the biggest risk for the lifeboat would come if the current crisis affected sectors of the economy that tended to have relatively large DB deficits.
According to the report, around a quarter of the FTSE 350 comprises companies that are in the most “at-risk” sectors in the current crisis, including hospitality and entertainment, manufacturing, aerospace and high street retail.
If several of these larger employers were to face insolvency in the future, even the more serious £20bn hit could prove to be an underestimate, LCP added.
When it comes to solutions, the lifeboat fund has a range of options to absorb even a relatively large series of additional liabilities.
First, the PPF could delay its funding goal — the lifeboat aims to be self-sufficient and 110 per cent funded by 2030 — which would allow the fund “to go on investing in growth-seeking assets for longer, and could also see significant levies in place for longer and would reduce the need to rely exclusively on levy increases”, LCP stated.
Sara Protheroe, chief customer officer at the PPF, had said in April the PPF was willing to make this move if needed to face the Covid-19 crisis.
Another option was raising levies on solvent schemes. In 2019, the lifeboat fund was 118.9 per cent funded with reserves of £6.1bn, and collected £561m in levy fees.
According to its self-sufficiency plan, the levy is supposed to be reduced over the coming decade. However, faced with the current scenario as a result of the pandemic, the PPF could choose to maintain or increase the fees it charges to schemes, LCP stated.
“There is a legal limit of 25 per cent on levy increases from one year to the next, but the statutory ‘levy ceiling’ set by parliament would allow the PPF to almost double levies over time if it wished,” the report read.
The lifeboat fund could also make changes to its investment strategy, chasing higher returns through taking on higher risk.
Reducing benefits off the table
The PPF also has the “nuclear option” of reducing benefits to its members, which would require the approval of parliament.
Reducing payments to pensioners to 90 per cent, broadly in line with the compensation paid to non-pensioners, would reduce the PPF’s deficit by around £2bn while also reducing the number of schemes that entered the lifeboat, LCP said.