How to save money on your PPF levy

There are two levies collected annually by the Pension Protection Fund (PPF) from defined benefit (DB) schemes.

These are the scheme-based levy, which is based on the number of scheme members, and the risk-based levy, which is based on a scheme’s underfunding and the risk that its sponsoring employer may become insolvent.

Schemes should start work now, with the employer, to consider how they can reduce the PPF risk-based charge for 2012/13. This accounts for 80% of the total levy.

The PPF uses Dun & Bradstreet to assign a failure score to the employer, which is based on the likelihood of the sponsoring employer becoming insolvent, stopping trading and being unable to pay all of its creditors within the next year.

Contingent assets

One way that schemes can make savings on their PPF risk-based levy is by entering into a contingent asset deal, using the PPF-recognised agreements.

These include a parental guarantee from a parent company within the same group as the participating employer in a DB scheme; a charge over cash, real estate or shares in favour of the scheme trustees; or a letter of credit and bank guarantees.

Scheme issues

A contingent asset is not only a way to reduce the scheme’s risk-based levy for companies but also to give the schemes some security.

A charge over property makes the trustees a secured creditor, so, if the company were to fail, they would be higher up the list of creditors. 

Schemes are more likely to consider investing in a greater percentage of equities or a longer recovery plan if they have a PPF contingent asset; and the company demonstrates its long term commitment to the pension scheme, which reassures trustees.

Company issues

Financial Directors are keen on PPF contingent assets as they reduce expenditure on the levy, either directly as a scheme expense or indirectly through employer contributions.

However, the agreements are tightly drafted in favour of the trustees, which leave little manoeuvre for the company. The PPF requires the contingent assets to be re-certified each year.

If entering into a contingent asset, the employer should consider:

• whether they have an asset that can be charged for an indefinite period of time.

• does the proposed contingent asset breach any covenants, negative pledges to the bank or restrictions under its borrowing arrangements.

• the resulting reduced borrowing capacity.

If the company prefers a contingent asset rather than an injection of cash, a business case should be presented to the scheme, with the company’s rationale.

For example, although a cash contribution would improve the scheme’s funding position and there would be tax relief on the contribution, there would be a cash flow impact on the company and lack of control once the cash has been paid across to the scheme. 

Act now

Contingent assets have to be registered with the PPF by 5pm on March 31, 2012, to be taken into account for the 2012/13 risk-based levy.

Employers and trustees should start a discussion now with the employer and parent company/other group companies to decide on the most appropriate contingent asset to use.

Liaise with the actuary to quantify which is the most cost effective contingent asset for your scheme and for the company.

Check with the company's financial director to ensure that there are no negative pledges to the bank which could block the use of a contingent asset.

Seek advice from your lawyer about the documentation required and whether an overseas lawyer should also be instructed – which is required if the parent company is not a UK company.

If you are considering using a contingent asset for 2012/2013, start the process now.

Sasha Butterworth is a partner and head of pensions at national law firm TLT.