Perspectives

PPF Levy 2019/20

What PPF guarantee certification looks like this year

Harry Morgan and Simon Kew from Deloitte UK’s ‘Financial Advisory – Pensions’ team look at the impact of the Pension Protection Fund’s 2019/20 levy announcement, on the certification of guarantees for pension schemes looking to reduce their PPF levy.

With all the Brexit maelstrom, you could be forgiven for thinking that nothing else matters at the end of March 2019. However, as well as leaving the EU (probably), PPF contingent assets require certification if they are to be eligible for PPF levy reduction in 2019/20 – it could be a busy week.

Why is this important?
The PPF is funded by a combination of the assets that it accepts from transferring schemes and an annual levy on the schemes that are eligible for entry to the PPF – think of it as an insurance premium. However, unlike car insurance, you can’t go onto a comparison website to shop around a range of providers for the lowest premium.

The PPF has set its levy target for 2018/19 at £550m, with a target for 2019/20 of £500m. The 2018/19 levy of £550m equates to an average £100k each (with some significantly higher) for the 5,450 schemes submitting data for the 2018 Purple Book so a not insubstantial annual cost.

What can be done to reduce the annual levy?
The levy is a combination of a scheme based levy and a risk based levy. Whilst the scheme based levy is unavoidable, the risk based levy is calculated based on the potential risk of needing to rely on the PPF lifeboat. This risk is a combination of the likelihood of insolvency of the sponsoring employer, and the level of underfunding on a s179 basis. The higher the risk or deficit, the higher the levy. It therefore comes as no surprise, that if either of those elements can be reduced, then so can the levy, which is where contingent assets come in.

The availability of a contingent asset to support a scheme can reduce the risk of a scheme entering the PPF or the level of underfunding, and thus the levy that a scheme is required to pay.

What contingent assets can be put in place?
There are three types of contingent asset:

  • Type A – parent or group company guarantee
  • Type B – security over cash, real estate or securities
  • Type C – letters of credit and bank guarantees

The 2018 Purple Book1 notes that 519 Contingent Assets were certified for the current 2018/19 levy year compared to 601 in the prior year. Despite potentially being the hardest to put a value on, Type A are by far the most popular. Of those certified in 2018/19, 363 (70%) were Type A with 142 (27%) being Type B and only 14 (3%) Type C. Interestingly, the overall number of certifications is the lowest level since 2008/09 and a continuation of a downward trend from a peak of over 900 in 2011/12.

In order for the PPF to agree to a reduction in the levy, then the contingent asset requires certification. New guidance and forms for contingent asset agreements were introduced in January 2018.
Where does the covenant reviewer fit in?

In order to be certified, a contingent asset needs a Realisable Recovery2 value assigned to it. This is effectively the amount that the scheme trustees are reasonably satisfied that the guarantor could meet in the event of a sponsor insolvency event.

As noted earlier, a Type A contingent asset is potentially the hardest to put a value on, which is where external advice can be invaluable. The trustees, along with their professional advisors, need to assess the expected Realisable Recovery value that they wish to certify the contingent asset for. Certify too little and potential levy reduction could be missed. Certify too much and there is a risk that the PPF rejects the guarantee which leaves no levy reduction at all. Good advice is critical. The trustees also need to keep comprehensive records of the certification they have given, to evidence their assertion of the value of the guarantee.

The PPF selects a proportion of contingent assets for a more detailed review (in conjunction with professional advisors), and justification from the trustees that a guarantor would be able to fund the Realisable Recovery in the event of an insolvency of the sponsor.

Levy saving > £100k
If the potential levy saving as a result of having a Type A guarantee is more than £100k then a guarantor strength report (“GSR”) is required from an independent, external professional advisor. This was a new requirement introduced by the PPF for the 2018/19 levy year. The trustees need to certify that they have obtained a GSR and it needs to be submitted to the PPF as part of the annual certification process. If the levy saving is less than £100k but close to it, or is not known, then the PPF recommends commissioning a GSR regardless. Even at a lower level of Realisable Recovery, the justification for this amount can be a complex exercise.

With a GSR that is being submitted to the PPF, the onus is then on the covenant advisor to conclude (or otherwise) that the guarantor is good for the guarantee in the event of an insolvency of the employer. This will need to also form a view on whether an insolvency of the employer could precipitate an insolvency of the guarantor – a key point.

As it is the covenant advisor opining on the strength of the guarantor, then the PPF requires it to give a duty of care to the PPF at or above the amount of the levy saving and for this to be backed up by professional indemnity cover for at least this amount.

If all this is in place and the report is submitted on time with the rest of the documentation (hard copy to the PPF by 5pm on 1 April 2019), and prepared in a way which is consistent with the guidance, then the PPF will deem the Risk Reduction Test to have been met, and the contingent asset won’t be selected for any more detailed review.

Where a GSR has been submitted previously, the PPF will accept a “refresher” report. However, this must be complete and up-to-date by reference to 2019/20 requirements and the prior report must be appended as part of the hard copy submission.

Next steps

  • Consider, with your professional advisors, whether you have any contingent assets to certify / re-certify / re-execute.
  • Form an initial view of the Realisable Recovery value of the asset.
  • Calculate the potential PPF levy saving if the asset is certified.
  • Conclude if a GSR will need to be, or should be, commissioned from an external covenant advisor.
  • Be mindful of the 31 March deadline – it will come around quicker than you can say “Leave or Remain”…

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1 The Pensions Universe Risk Profile issued by the PPF providing comprehensive data on the UK universe of private sector Defined Benefit pension schemes.

2
Defined in the PPF’s 2018/19 Contingent Asset Appendix, paragraph 4(15).

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