PPF eyes deteriorating credit ratings among DB sponsors

In March 2019 just over £1bn of pension promises related to schemes considered a ‘contingent liability’ by the PPF. A year later this figure now stands at £3.7bn, the PPF reported on Thursday.

Contingent liabilities are not a prediction, but “consider events that are deemed possible over the next 12 to 18 months”, the report states. They represent potential, not estimated, threats to PPF funding.

It really will depend on what schemes in the universe are ultimately the ones that come our way. There are some big deficits out there.

Lisa McCrory, PPF

The sharp rise was driven by an increased number of sponsors of large pension schemes, the credit scores of which had deteriorated over the course of the year.

In its report, the PPF categorises the risk of possible future claims according to three types. The first is where a past claim has been made and rejected, but the PPF expects a future claim to be successful. The report states no schemes fall into this category.

Type two contains schemes deemed highly likely to suffer an insolvency event in the coming months, as based on evidence provided by the scheme’s trustees or the Pensions Regulator. 

The report estimates the potential net liability for this category to have risen by 445.8m since March 2019, to £527.3m from £81.5m.

But the biggest increase is in the number and potential net liability of type three schemes, which are those deemed to have a high insolvency risk, for instance “if the Experian insolvency score would place it in levy band 10 or, for the biggest schemes, if the sponsoring employer has a credit rating of CCC+ or worse,” the report explains.

The potential net liability for this category rose to £3219.4m as of March 2020 from £923.6m in 2019. 

The report states this is not intended “as a measure of claims over the period”, but is rather “a measure of the schemes that are deemed the highest risk of failure for levy purposes”.

PPF remains confident of success

Speaking in a Pensions Expert podcast, PPF chief actuary Lisa McCrory said the PPF was “trying to give an indication of the schemes that we believe are the highest risk of an insolvency event”. 

“We break those contingent liabilities into two groups, ones where we feel there is a very high chance of insolvency – and that number has gone up a bit over the year – and then the second group is looking more at those schemes that are in the lowest levy bounds or have a low credit rating.

“The reason for the jump this year is that there has been a number of downgrades and credit ratings for some of the larger schemes that we protect. But even still, we wouldn’t expect all the schemes to ultimately end up on a claim on the PPF,” she said.

Estimating claims themselves is very difficult, she continued, as you have first to estimate what number of schemes are likely to go insolvent and then project what the underfunding will be in those schemes.

“And that’s incredibly tricky to do,” she said, not least because the number of claims does not necessarily correlate with the value of those claims.

“It really will depend on what schemes in the universe are ultimately the ones that come our way. There are some big deficits out there.” 

Important to give a ‘clear signal’ on the levy.

LCP partner Jonathan Wolff told Pensions Expert the PPF had made a decision to keep the strain of coronavirus-driven economic uncertainty out of its levy. 

“This report is a reminder that the PPF has multiple levers to pull when times get tough. They have clearly decided not to let the levy take the strain. Instead they are prepared to live with a significantly reduced probability of reaching their long-term funding target,” he said.

The PPF’s probability of success, which uses stochastic modelling to estimate outcomes, has dropped to 83 per cent from 89 per cent at the same time last year.

Asked if this was a fair critique, PPF chief executive Oliver Morley replied: “It is really a question of balance, isn’t it? And that’s what we’re trying to achieve.”  

“When it comes to the levy, we’re also very conscious that the levy is obviously a charge upon schemes. And so we don’t want to be in a position where we are really drawing in excess of what we would consider to properly reflect risk in the market,” he continued. 

“We want to be able to give people as clear a signal on levy as we can at the moment, but also reflect some of the performance and risk that we’ve seen over the last year.”

The PPF’s reserves, in effect its surplus assets above liabilities it has accepted, stood at £5.1bn at March 31 2020, compared with £6.1bn the previous year.

Nevertheless, its assets grew to £36.1bn from £32.1bn, with an investment return of 5.2 per cent – the same as in 2018-19 – despite market turbulence caused by the pandemic.

There were 36 new claims in 2019-20, up from 23 the previous year, but the value of these claims was lower – £300m compared with £1.7bn in 2018-19, the report stated.

RPI-CPIH switch a cause for concern

Joanne Shepard, director at Willis Towers Watson’s retirement practice, told Pensions Expert of the proposed switch from the retail price index to the consumer price index including housing: “Like many schemes holding index-linked gilts but without RPI linked liabilities, the PPF would be adversely affected by proposals to align RPI with CPIH – it says alignment from 2030 could reduce reserves by £600m beyond what it thinks is already priced in.”

Asked to respond to the suggestion the switch could cost the PPF as much as £600m if implemented in 2030, and more if it is implemented earlier, Mr Morley said the PPF had made its views known.

“We have responded to the government’s consultation on the timing of the RPI CPI change, and we’ve been fairly clear about our concerns on it, and the financial impact that will be that will be there,” he said.