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.
PPF’s toolbox
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.
In the "insolvencies double" scenario, the PPF would be facing a £7bn shortfall, which could be covered purely by future investment returns if the scheme maintains its current investment strategy, as long as these go according to plan, the report stated.
In the worst-case scenario — the "deeper downturn" — more options will be needed, since raising levies as well as maintaining the current investment strategy would not solve the issue, LCP added.
“But lengthening the time horizon to the PPF meeting self-sufficiency for around four to five years could help to give the required breathing space to make up the circa £18bn shortfall in full, again without raising levies,” the report stated, adding that choosing to raise fees would help to reduce the timescale.
Jonathan Wolff, partner at LCP, recognised the PPF had a range of levers it could pull to absorb increased cost pressures without having to resort to cutting benefits to members.
“But we cannot be complacent. Recent history has been a reminder that the crucial question is whether the insolvencies that we are likely to see in the coming years will hit firms which also have large DB deficits,” Mr Wolff said.
“There remains a risk that too many such insolvencies could put a serious strain on the system.”
In response to the report, a PPF spokesperson said: “Based on our ongoing modelling, we remain confident that our sustainable funding strategy and diverse investment approach equips us well to weather the current market volatility and future challenges.
“Our priority is to continue to provide compensation for our members, and remain a safety net to those protected by the PPF for as long as they need it.”
Possible legal challenges
When it comes to reducing benefits, LCP stated the government should have “the ultimate back-up plan of being able to reduce benefits in extremis, because it gives it the freedom to take the investment risk or push back the time to self-sufficiency”.
However, Penny Cogher, partner at Irwin Mitchell, argued the PPF would find it much harder to alter or reduce benefits without having further legal challenges.
The benefits provided by the lifeboat fund have been the target of a string of high-profile legal processes in recent years.
In 2018, the Court of Justice of the European Union determined that PPF members should not receive less than 50 per cent of their entitled benefits, in the event of the insolvency of their employer.
In June this year, the High Court ruled on the PPF’s methodology for implementing the judgment. The lifeboat recently announced that it will challenge the judge’s argument that survivors’ benefits should also be subject to the 50 per cent test.
Ms Cogher said: “As the current legal disputes show, just because the level of benefits to be provided by the PPF is written in legalisation, this doesn’t mean to say that even if parliament approves a reduction to the PPF’s benefit structure, this type of change won’t be open to further challenge through the courts.”
She also noted that raising levies for the “financially better off schemes and their employers politically starts to look like penalising them for surviving Covid-19 and doesn’t seem a very attractive option to the government”.
Ms Cogher added: “Perhaps overall the days of the PPF are numbered. Perhaps a better approach is for the government to start looking at taxing investment managers and custodians more specifically when they provide pension trustee services for DB and defined contribution schemes, and use these monies to provide a pensions lifeboat for pension savers.”
maria.espadinha@ft.com
