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Chapter 5 - Pension Protection Fund (PPF)

This is a chapter from the Bloomsbury Professional book Freshfields on Corporate Pensions Law 2012, which is a guide for employers to the law relating to occupational pensions in the UK. This is an increasingly complex area driven by a combination of increased costs and liabilities - for example driven by increasing longevity and reduced asset returns; changes in the law driven by UK legislation and European law; and judicial decisions on the web of interlocking obligations in a pension scheme. The book is written in a clear and user friendly way for use by lawyers and non-lawyers - for example, finance directors, treasurers, HR departments; pension managers, legal counsel and trustees. The book looks at occupational pensions from the perspective of the employer. Written by the pensions team at Freshfields, a leading international law firm, the book contains "bite-sized" analysis of legal topics on pensions law. Over 80 individual chapters are gathered together in Parts dealing with topics including funding; debt on the employer - section 75 issues; and pensions regulator - moral hazard powers. The book is up to date as at the end of 2011 and includes the recent changes by the Pensions Act 2011, the Court of Appeal decision in the Nortel case (on priority of claims in an insolvency) and the Stena and Pilots decisions on funding obligations.

This Chapter, the index and the table of contents are FREE to view, as a sample of the book's contents. To view the other chapters, please subscribe to Books online.

General Editors: David Pollard and Charles Magoffin

Chapter 5 Pension Protection Fund (PPF)

5.1 The Pension Protection Fund

Summary

The Pensions Act 2004 provided for the establishment of the Pension Protection Fund (PPF). This aims to provide members with a certain level of protection in the event of scheme insolvencies.

This section considers two areas:

  • the establishment of the Board of the PPF and its functions;

  • how the PPF operates – what schemes it covers, how it will assume responsibility for a scheme.

Establishment and operation of the PPF

5.1.1 The Pensions Act 2004 established the Pension Protection Fund (PPF) with effect on and from 6 April 2005.

The Board of the PPF is established as a body corporate under the Pensions Act 2004. The Pensions Act provides that the Board is not to be regarded as a servant or agent of the Crown, or as enjoying any status, privilege or immunity of the Crown.

The Board's primary function is to 'hold, manage and apply' the PPF and the Fraud Compensation Fund.

The Board may delegate any of its functions to any executive members of the Board, any staff member of the Board or any of the Board's committees or sub-committees.

Broadly, the PPF is designed to provide a safety net for eligible occupational pension schemes. If a scheme is eligible and a qualifying insolvency event occurs (ie the employer enters formal insolvency in Great Britain after 5 April 2005), an 'assessment period' will start.

Eligible schemes

5.1.2 The Pensions Act 2004 envisages that the PPF will cover all 'eligible schemes'.

An eligible scheme is defined as an occupational pension scheme which:

  • is not a money purchase scheme;

  • is not a prescribed scheme or a scheme of a prescribed description; and

  • is not being wound up immediately before a prescribed date (fixed as 6 April 2005).

The PPF does not, therefore, apply retrospectively to schemes already being wound up or where winding up has been completed before April 2005.

Schemes which are not eligible schemes include unfunded public service pension schemes, schemes which have a ministerial guarantee, schemes which are not tax registered and schemes with fewer than two members.

A scheme may also cease to be eligible if its trustees enter into a binding agreement with an employer to reduce the amount of a s 75 debt that is recoverable.

Assessment period

5.1.3 During the assessment period the PPF will look at the scheme to see if it has sufficient funds to meet the protected level of benefits provided by the PPF.

If the scheme does not, and the insolvency practitioner states that a scheme rescue is not possible, the scheme will enter the PPF (the first schemes entered in December 2006).

On entering the PPF, all the assets and liabilities (other than defined benefit liabilities to and in respect of members) of the scheme are transferred (under the Pensions Act 2004) to the PPF, which will:

  • take over responsibility for the transferred external liabilities; and

  • take over responsibility for any money purchase benefits; and

  • provide a protected level of benefits to the members who were entitled to defined benefits.

Insolvency event

5.1.4 An insolvency event is defined in s 121 of PA 2004 and reg 5 of the PPF Entry Rules Regulations.[1] The definition is important as it is used for much of PA 2004 and for the amended employer debt provisions in s 75 of the PA 1995 – see s 75(6C)(a).

An insolvency event (in relation to a company) is:

  • a nominee submitting a report for a voluntary arrangement under Pt 1 of the Insolvency Act 1986 (IA 1986);

  • the directors of a company filing or lodging with the court documents and statements under para 7(1) of Sch A1 to IA 1986 dealing with the moratorium on directors proposing a voluntary arrangement;

  • an administrative receiver within IA 1986, s 251 being appointed;

  • the company entering administration within the meaning of para 1(2)(b) of Sch B1, IA 1986;

  • a resolution being passed for the voluntary winding-up of the company without a declaration of solvency under IA 1986, s 89;

  • a creditors' meeting being held under IA 1986, s 95 to convert an MVL (members' voluntary liquidation) into a CVL (creditors' voluntary liquidation);

  • an order for the winding-up of the company being made by the court under Pt 4 or 5 of IA 1986;

  • an administration order being made by the court in respect of the company by virtue of any enactment which applies Part 2 of IA 1986 (administration orders) (with or without modification);

  • a notice from an administrator under para 83(3) of Sch B1 to IA 1986 (moving from administration to creditors' voluntary liquidation) in relation to the company being registered by the registrar of companies;

  • the company moving from administration to winding-up pursuant to an order of the court under r 2.132 of the Insolvency Rules 1986 (conversion of administration to winding up – power of court); or

  • an administrator or liquidator of the company, being the nominee in relation to a proposal for a voluntary arrangement under Pt 1 of IA 1986 (company voluntary arrangements), summoning meetings of the company and of its creditors to consider the proposal, in accordance with IA 1986, s 3(2) of (summoning of meetings).

The definition of 'insolvency event' includes any winding-up by the court. Such a winding-up could occur in relation to a solvent employer.

The statutory list in ss 121(2) to (4) and in any regulations under s 121(5) is definitive.

Although not listed in PA 2004 or the PPF Entry Rules Regulations, the various insolvency regimes under the Banking Act 2009 will also count as an insolvency event for these purposes. The same applies to building societies – see the Building Societies (Insolvency and Special Administration) Order 2009.[2]

Note that the following are not an insolvency event under s 121:

  • a resolution being passed for a voluntary winding-up with a declaration of solvency (ie a members' voluntary liquidation);

  • appointment of a provisional liquidator;

  • appointment of a receiver who is not an administrative receiver (eg an LPA receiver);

  • entry of the company into a non-UK insolvency proceeding.

Note that a members' voluntary liquidation (MVL) involves a declaration of solvency being given by the directors and so (in principle) the company is not insolvent. MVLs are generally outside the new definition of an 'insolvency event' in the Pensions Act 2004, but an MVL triggers a s 75 debt (see Debt on the employer, 3.1).

The definition of an 'insolvency event' relates only to insolvency proceedings under the Insolvency Act 1986 and so will not apply to an insolvency proceeding outside the UK even if applying to a UK company (eg under the Cross-Border Insolvency Regulations 2006 (SI 2006/1030)).

Generally a scheme can only enter an assessment period (or ultimately the PPF) if the employer (or for a multi-employer scheme all the employers) have a qualifying insolvency event occur in relation to them.

Qualifying insolvency event

5.1.5 A qualifying insolvency event in relation to an employer of an eligible scheme is an insolvency event that occurs on or after 6 April 2005. This is irrespective of any previous insolvency event prior to this date.

In addition, in order to be an eligible scheme for entry into the PPF, the scheme must not have commenced wind up before 6 April 2005.

The guidance on the PPF website summarises the position.

Where there is a multi-employer scheme, the definition of 'qualifying insolvency event' can be modified).

Entering the PPF outside insolvency – s 129

5.1.6 But there is an alternative route available in some (limited) cases. Sections 128 and 129 of PA 2004 allow the trustees of a scheme to apply to the PPF if they become aware that the employer in relation to the scheme is unlikely to continue as a going concern. This does not require a formal insolvency of the employer in the UK, but is only available where the prescribed circumstances in reg 7 of the PPF Entry Rules apply. These are limited to public bodies, charities and trade unions in relation to which it is not possible for an insolvency event (as defined in PA 2004, s 121) to occur.

PPF protected benefits

5.1.7 The PPF protected benefits[3] are summarised on its website as set out in the table below:

Compensation

Broadly speaking the Pension Protection Fund will provide two levels of compensation which are outlined below.

  • 1. For individuals that have reached their scheme's normal pension age or, irrespective of age, are either already in receipt of survivors' pension or a pension on the grounds of ill health, the Pension Protection Fund will generally pay 100% level of compensation.

    In broad terms and in normal circumstances, this means a starting level of compensation that equates to 100% of the pension in payment immediately before the assessment date (subject to a review of the rules of the scheme by the Pension Protection Fund).

    The part of this compensation that is derived from pensionable service on or after 6 April 1997 will be increased each year in line with inflation capped at 2.5%. This could, potentially, result in a lower rate of increase than the scheme would have provided.

  • 2. For the majority of people below their scheme's normal pension age the Pension Protection Fund will generally pay 90% level of compensation.

    In broad terms and in normal circumstances, this means 90% of the pension an individual had accrued (including revaluation) immediately before the assessment date (subject to a review of the rules of the scheme by the Pension Protection Fund) and revaluation in line with the increase in the inflation between the assessment date and the commencement of compensation payments, this revaluation being subject to a cap of 5% compound per annum in respect of compensation attributable to pensionable service prior to 6 April 2009, and a cap of 2.5% compound per annum in respect of compensation attributable to pensionable service on or after 6 April 2009.

    This compensation is subject to an overall annual cap, which, as at April 2011, equates to £29,897.42 at age 65 after the 90% has been applied. (the cap will be adjusted according to the age at which compensation comes into payment. Please refer to the current compensation cap factors for caps applicable at other ages).

Once compensation is in payment, the part that derives from pensionable service on or after 6 April 1997 will be increased each year in line with inflation, capped at 2.5%. Again, this could result in a lower rate of increase than the scheme would have provided.

In addition there will also be compensation for certain survivors.

IMPORTANT

The way in which PPF compensation is calculated changed in 2011. This is because the Government has chosen to use the Consumer Prices Index (CPI) with which to calculate annual increases, rather than the Retail Prices Index (RPI). This change is fully explained in the letters below. Please choose the one most appropriate to your situation:

PPF – Retired Member

PPF – Deferred Member

COMPENSATION AND DIVORCE – FACTSHEET

Regulations which set out how Pension Protection Fund (PPF) compensation may be affected for members who get divorced/have their civil partnership dissolved came into force on 6 April 2011.

These new rules make provision for a member's pension compensation to be shared with their ex-spouse or former civil partner if the court makes a pension compensation sharing order.

For more information, please view the factsheet by clicking on the link above. You can also view the PPF Divorce Charges.

The Pension Protection Fund has the ability to alter the levy to meet its liabilities. However, in extreme circumstances compensation could be reduced.

  • Revaluation and indexation could be reduced by the Pension Protection Fund if circumstances required it.

  • Levels of compensation could be reduced by the Secretary of State on the recommendation of the Pension Protection Fund.

Source: PPF website http://www.pensionprotectionfund.org.uk/Pages/Compensation.aspx

Summary of PPF role

5.1.8 The PPF summarises its role in its guidance to scheme trustees as follows:

The assessment period

If a qualifying insolvency event occurs in relation to an employer of an eligible scheme, this will trigger the beginning of an assessment period. During this period the Pension Protection Fund will assess whether or not it must assume responsibility for the scheme.

What happens during an assessment period?

During the assessment period the Pension Protection Fund looks to determine whether a scheme is eligible for entry.

During this period the scheme continues to be administered by its trustees, subject to various restrictions and controls.

During the assessment period the Pension Protection Fund will look to establish the answer to two main questions:

  • 1 Can the scheme be rescued? (For example, can the original employer continue as a going concern, or is another employer going to take the original employer over and assume responsibility for the scheme?); and

  • 2 Can the scheme afford to secure benefits which are at least equal to the compensation that the Pension Protection Fund would pay if it assumed responsibility for the scheme?

If the answer to either of these questions is 'yes' then the Pension Protection Fund will cease to be involved with the scheme once the relevant processes and procedures have been completed.

However, if the answer to both the questions is 'no', and the relevant process and procedures have been completed, then the Pension Protection Fund will assume responsibility for the scheme and compensation will then become payable.

A Pension Protection Fund assessment period is likely to last a minimum of one year and could be longer, depending on the complexity of the financial situation of both the employer and the scheme, and the possibility of a scheme rescue.

The role of trustees

During an assessment period, the trustees of the scheme retain responsibility for the administration of the scheme and for communicating with and making pension payments to scheme members. The trustees must continue to Act in the interests of all the scheme members.

However, during an assessment period, various restrictions and controls will apply in relation to the scheme. In particular, pensions will be restricted to Pension Protection Fund compensation levels [see 'compensation' for more details].

The role of the Pensions Regulator

Once a scheme enters an assessment period, the Pension Protection Fund will work closely with the Regulator, keeping it informed of any relevant developments relating to the scheme. The Regulator may use its powers when problems arise on individual schemes.

For further information on the Pensions Regulator, visit its website at www.thepensionsregulator.gov.uk.

The role of the Pension Protection Fund

During an assessment period, the Pension Protection Fund will undertake a monitoring role in relation to the trustees of the scheme. This is to ensure that the trustees maintain the scheme in an appropriate manner for potential entry to the Pension Protection Fund. In certain circumstances, the Pension Protection Fund can issue directions to trustees in relation to areas such as the investment of the scheme's assets, the incurring of expenditure and the bringing or conduct of legal proceedings.

The Pension Protection Fund will also monitor the progress of the insolvency proceedings, liaising closely with the insolvency practitioner.

Where the Pension Protection Fund ultimately assumes responsibility for a scheme, arrangements will then be made to pay compensation to the scheme members.

Source: PPF website.

Assessment period

5.1.9 An assessment period starts when a qualifying insolvency event occurs. This may well be before the trustees receive the notice from the insolvency practitioner.

The PPF will only confirm that it considers the scheme to be eligible after it receives the notice from the insolvency practitioner (its guidance indicates that it will try to do this within 28 days of receipt of the notice and relevant information, but this is not a period fixed in the legislation). The effect will be to confirm that the assessment period started when the relevant insolvency started.

During the assessment period:

  • The PPF Board considers whether or not it needs to take over the pension scheme;

  • Accrual of benefits and the powers of the trustees are limited during this period:

    • – No new members can be admitted.

    • – No further contributions can be paid to the scheme – save as prescribed in regulations (or which fell due and payable before the assessment period). Regulations allow an employer to pay further contributions where those contributions relate to:

      • (a) all or any part of that employer's liability for any debt due from him to the scheme under s 75 of PA 1995 which has not yet been discharged; and

      • (b) the value of an asset of the scheme arising from a debt or obligation referred to in s 143(5)(a) to (d) of the Act (Board's obligation to obtain valuation of assets and protected liabilities). Section 143(5) relates to statutory obligations on an employer under various provisions, including s 75 of the PA 1995 and under contribution notices, financial support directions or restoration orders issued by the Pensions Regulator under PA 2004.

    • – No benefits can accrue, save for an increase which would otherwise accrue in accordance with the scheme or an enactment. This seems to envisage that there will be no additional pensionable service. Money purchase benefits can also accrue.

    • – The board of the PPF can give directions to the trustees (or employer or scheme administrator) regarding exercise of his powers in relation to investment of scheme assets, expenditure, conduct of legal proceedings and amendments to the scheme.

    • – Schemes cannot start to wind up unless this is ordered by the Pensions Regulator.

    • – Transfers out of the scheme can only be made in prescribed circumstances.

    • – Contribution refunds (for members whose pensionable service terminates with less than two years qualifying service).

    • – Payment of scheme benefits are limited to the amounts that would be protected by the PPF.

  • The Board of the PPF is able to validate actions that would otherwise be prohibited (and so void).

  • The PPF takes control of all rights of the pension scheme trustees as creditors. All relevant documents about creditor status (eg notices of creditor meetings and proof of debt forms) should be sent to the PPF (and not the trustees).

  • All payments from the employer should go to the PPF.

The trustees remain responsible for the administration of the scheme.

End of assessment period

5.1.10 The PPF Board ceases to be involved with the scheme (and the assessment period ends) if a withdrawal event occurs. A withdrawal event includes the issuing by an IP of a withdrawal notice confirming that a scheme rescue has occurred.

A withdrawal notice requires the IP to confirm that a scheme rescue has occurred.

An assessment period ends when:

  • the PPF assumes responsibility for the scheme; or

  • a withdrawal notice becomes effective (eg that a scheme rescue has occurred).

According to the PPF guidance for trustees:

The assessment period will conclude with the Board of the Pension Protection Fund assuming responsibility for a scheme when the following conditions have been met:

  • A pension scheme rescue is not possible and a scheme failure notice is binding;

  • A section 143 valuation shows that the pension scheme's assets are not sufficient to secure the Pension Protection Fund protected liabilities; and

  • The Board of the Pension Protection Fund's approval of the section 143 valuation is binding.

Within two months of the section 143 valuation becoming binding the Pension Protection Fund is required to issue a transfer notice.

On receipt of the notice the trustees are discharged of their responsibilities for administering the scheme and the assets and prescribed liabilities are transferred to the Board of the Pension Protection Fund.

The pension scheme is then treated as having wound up.

Source: PPF Guidance for Trustees. www.pensionprotectionfund.org.uk/TrusteeGuidance/DetailedTrusteeGuidance/Pages/ResponsibilityforSchemeAssumed.aspx

End of assessment period

5.1.11 At the end of the assessment period:

  • If the valuation shows that the scheme assets are sufficient to pay at least protected liabilities, the PPF has no further involvement with the scheme and the scheme is required to wind up outside of the PPF.

  • If the valuation shows that the scheme assets are insufficient to pay protected liabilities the scheme enters the PPF. The property, rights and liabilities transfer to the Board of the PPF and the trustees or managers are discharged of their responsibilities towards the scheme and the scheme is treated as if it were wound up.

Source: PPF guidance for trustees: www.pensionprotectionfund.org.uk/index/TrusteeGuidance/DetailedTrusteeGuidance/Pages/OverviewoftheAssessmentPeriod.aspx.

Pensions and a company entering administration – an overview

5.1.12 The position can get quite complex depending on how many participating employers are in the scheme and what the scheme rules say.

Assuming that a company is the only employer and it enters administration, the following happens in relation to the pension scheme:

  • 1 The scheme enters an 'assessment period'. The scheme is frozen during this period meaning that there is no further accrual of benefits, no contributions that were not already due are payable (save for any s 75 debt – see 5 below) and benefits are only payable out of the scheme at the PPF protected level. In practice this means that the administrator will stop deducting contributions from pay. The PPF protected level of benefits is (broadly) 100 per cent of pension (for those aged over the NRA) and 90 per cent of benefits, subject to a cap (of about £27,000 pa) for those aged under NRA (even those who have retired early). There are special rules on ill-health pensions and on pension increases.

  • 2 The administrator has to notify the trustees, the Pension Protection Fund (PPF) and the Pensions Regulator of his appointment and which schemes are in place. The Regulator may (but does not have to) appoint an independent trustee.

  • 3 The trustees stay in place but are subject to direction by the PPF. Any payments due have to be to the PPF.

  • 4 The administrator needs to decide in due course whether or not a scheme rescue will be possible. If it is he serves a 'scheme rescue notice'. A scheme rescue would be if the company exited administration in a solvent form or if someone came in and took over the scheme. If a scheme rescue is not possible, the administrator serves a 'scheme failure notice'.

  • 5 Entry into administration triggers a debt payable by the company under s 75 of the Pensions Act 1995 (this is unsecured and non-preferential). The debt is fixed by regulations (and quantified by the scheme actuary) as being the amount needed to fund the scheme up to full buy-out level. This debt does not become payable until certified and then only if a scheme failure notice has been issued (see 4).

  • 6 A full valuation of the scheme is carried out (a s 143 valuation) to check if the scheme has sufficient assets (taking account of any s 75 debt recovery) to fund the PPF protected level of benefits. This can take some time (usually at least a year). If it does have sufficient assets, then the scheme will usually wind up outside the PPF and provide what level of benefits it can. If it cannot then the PPF will take over the scheme and its assets and provide the PPF protected level of benefits itself. Either way the assessment period will then end.

For further details see the guidance on the PPF website: www.pensionprotectionfund.org.uk/index/TrusteeGuidance/DetailedTrusteeGuidance/Pages/OverviewoftheAssessmentPeriod.aspx

5.2 PPF protected benefits

5.2.1 Summary

This section looks at the level of protected benefits currently provided under the Pension Protection Fund when it takes over a scheme (usually following an employer insolvency).

The level of protection, but can also be relevant before an insolvency – the level of PPF benefit cover is relevant for the levy payable to the PPF and for the priority of benefits on a winding-up.

Schemes which are over 100 per cent funded on the PPF benefit basis may also be exempted from some notifiable events (see 13.1).

Issues for employers and trustees

5.2.2 The Pensions Act 2004 established the Pension Protection Fund (PPF) from 6 April 2005. This provides compensation for members of defined benefit (DB) pension schemes which begin winding up after April 2005 where the sponsoring employer is insolvent and leaves unfunded liabilities in the scheme. Employers and trustees need to understand what benefits are protected by the PPF, both when a pension scheme is ongoing and where a pension scheme starts to wind up.

Ongoing scheme

5.2.3 There are two key issues where a scheme is ongoing.

  • The PPF imposes a risk-based levy on pension schemes. The calculation of this includes an assessment of the difference between a scheme's assets and its protected liabilities. Trustees have to obtain actuarial valuations addressing this.

  • Disclosure requirements require information to be given to members about PPF protection.

Scheme in wind-up

5.2.4 Where a scheme winds up with insufficient assets to meet the protected level of liabilities (eg because the employer is insolvent) the assets of the scheme will transfer to the PPF, which will assume responsibility for providing the PPF protected level of benefit to members.

If, however, the scheme has sufficient assets to meet the PPF protected level of liabilities the scheme will not be taken on by the PPF. The trustees will then need to wind up the scheme in accordance with the statutory order of priority. This was amended by the Pensions Act 2004 so that (generally) priority is given to the protected PPF benefits before other DB benefits.

Benefits payable by the PPF

Basic principles

5.2.5 The protected benefit provisions are set out in Sch 7 to the Pensions Act 2004. The table below summarises the compensation payable to different categories of member.

The broad approach is that the PPF protected benefits will replicate some scheme-specific characteristics for a member's basic benefit (ie based on pension accrued to the start of the assessment period based on accrual rates, pensionable salary and pensionable service as defined in the scheme).

However, the PPF is not intended to replicate all a member's rights and benefits under the scheme. On issues such as dependants' pensions, pension increases and revaluation, the 2004 Act has taken a 'broad brush' approach (so the same PPF benefit applies to all, regardless of specific scheme rules). This was considered in 2004 by the then government to be 'equitable and … simpler to administer' (see Malcolm Wicks, Standing Committee B, Hansard, 30 March 2004, column 475).

The PPF protected benefits[4] are summarised on its website as set out in the table below:

Compensation

  • Broadly speaking the Pension Protection Fund will provide two levels of compensation which are outlined below.

  • 1. For individuals that have reached their scheme's normal pension age or, irrespective of age, are either already in receipt of survivors' pension or a pension on the grounds of ill health, the Pension Protection Fund will generally pay 100% level of compensation.

    In broad terms and in normal circumstances, this means a starting level of compensation that equates to 100% of the pension in payment immediately before the assessment date (subject to a review of the rules of the scheme by the Pension Protection Fund).

    The part of this compensation that is derived from pensionable service on or after 6 April 1997 will be increased each year in line with inflation capped at 2.5%. This could, potentially, result in a lower rate of increase than the scheme would have provided.

  • 2. For the majority of people below their scheme's normal pension age the Pension Protection Fund will generally pay 90% level of compensation.

    In broad terms and in normal circumstances, this means 90% of the pension an individual had accrued (including revaluation) immediately before the assessment date (subject to a review of the rules of the scheme by the Pension Protection Fund) and revaluation in line with the increase in the inflation between the assessment date and the commencement of compensation payments, this revaluation being subject to a cap of 5% compound per annum in respect of compensation attributable to pensionable service prior to 6 April 2009, and a cap of 2.5% compound per annum in respect of compensation attributable to pensionable service on or after 6 April 2009.

    This compensation is subject to an overall annual cap, which, as at April 2011, equates to £29,897.42 at age 65 after the 90% has been applied. (the cap will be adjusted according to the age at which compensation comes into payment. Please refer to the current compensation cap factors for caps applicable at other ages).

    Once compensation is in payment, the part that derives from pensionable service on or after 6 April 1997 will be increased each year in line with inflation, capped at 2.5%. Again, this could result in a lower rate of increase than the scheme would have provided.

    In addition there will also be compensation for certain survivors.

IMPORTANT

The way in which PPF compensation is calculated changed in 2011. This is because the Government has chosen to use the Consumer Prices Index (CPI) with which to calculate annual increases, rather than the Retail Prices Index (RPI). This change is fully explained in the letters below. Please choose the one most appropriate to your situation:

  PPF – Retired Member

  PPF – Deferred Member

COMPENSATION AND DIVORCE – FACTSHEET

Regulations which set out how Pension Protection Fund (PPF) compensation may be affected for members who get divorced/have their civil partnership dissolved came into force on 6 April 2011.

These new rules make provision for a member's pension compensation to be shared with their ex-spouse or former civil partner if the court makes a pension compensation sharing order.

For more information, please view the factsheet by clicking on the link above. You can also view the PPF Divorce Charges.

The Pension Protection Fund has the ability to alter the levy to meet its liabilities. However, in extreme circumstances compensation could be reduced.

  • Revaluation and indexation could be reduced by the Pension Protection Fund if circumstances required it.

  • Levels of compensation could be reduced by the Secretary of State on the recommendation of the Pension Protection Fund.

Source: PPF website www.pensionprotectionfund.org.uk/Pages/Compensation.aspx

Schedule 7, Pensions Act 2004: compensation payable by PPF

5.2.6 Pensioners over NPA (or ill-health) on assessment date

Pensioners NPA on assessment date

Pension benefits postponed after NPA on assessment date

Active[5]and deferred members over NPA on assessment date

Active members under NPA on assessment date

Position for member[6]

Entitled to periodic compensation from assessment date for life at 100 per cent (of the annual rate under admissible scheme rules).

Entitled to periodic compensation at 100 per cent(of annual rate under admissible scheme rules) from assessment date for life.

Entitled to periodic compensation at 100 per cent(of protected notional pension)from assessment date for life.

Pension based on scheme accrual rate, pensionable earnings and pensionable service(under admissible rules).

Where member survives to NPA, entitled to 90 per cent of protected notional pension (plus revaluation) from NPA for life.

Pension based on scheme accrual rate, pensionable earnings and pensionable service (under admissible rules).

Where member survives to NPA, entitled to 90 per cent of protected pension rate (plus revaluation)from NPA for life.

Protected pension rate is scheme accrued amount (under admissible rules).

Compensation cap?[7]

No.

Yes.

No.

Yes.

Yes.

Widow/widower

Entitled upon death of member (on or after assessment date) to half the annual rate/accrued amount that the member was entitled to, save in prescribed circumstances.

Lump sums on retirement

Not applicable.

Where entitlement to a scheme lump sum is postponed, member entitled to 100 per cent of accrued amount under scheme rules, as long as NPA reached.

Member entitled to 90 per cent of accrued amount(plus revaluation).

Commutation

Not applicable.

Can opt to commute for a lump sum up to 25 per cent of periodic compensation.

Early payment

Not applicable.

Regulations to prescribe circumstances when can have payment prior to NPA.

Board to determine actuarial reduction applicable.

Dependants[8]

Regulations may provide for compensation for partners and dependants of prescribed descriptions.

Increases to benefits in payment[9]

Annual increases of lesser of RPI (CPI from 1 January 2012) and 2.5 per cent on post-1997 serviceo nly.

[5] Schemefreezes as at the start of the assessmentperiod.

[6] The90  per cent and 100 per cent levels can be changedby regulations enacted by the Secretary of State.

[7] Initially £25,000pa. Usually increased each year. £29,897.42 (as at April 2011) after the 90 per cent has beenapplied.

[8] The Pension Protection Fund (Compensation) Regulations  2005.

[9] The rates of revaluation or indexation can be changed by the PPF Board.

Limitations on compensation payable

5.2.7 There are four important limitations on the compensation payable under the PPF:

  • Generally, members who have not reached normal pension age (NPA) at the date the scheme enters the PPF process will receive compensation at a rate of 90 per cent of their benefit (as opposed to 100 per cent for members who have already reached normal pension age or ill-health pensioners at that date). Normal pension age is defined as the age specified in the scheme as the earliest age at which the pension or lump sum becomes payable without actuarial adjustment (disregarding ill-health rules).

  • The basic benefit provisions of the scheme rules will apply only to the extent that they are 'admissible'. This excludes recent rule changes if those rule changes and recent discretionary increases have the combined effect of increasing the protected liabilities of the scheme.

    • – 'Recent rule changes' means changes which were made or took effect in the three years before the assessment date and any scheme rules which are triggered by the winding-up of the scheme or insolvency of the employer.

    • – 'Recent discretionary increases' are increases which came into effect in the three years before the assessment date.

  • Members who have not reached normal pension age (and who are not ill-health pensioners) are also subject to a compensation cap. Where the NPA is equal to 65, as at the date assessment begins (unless they are in receipt of a pension on the grounds of ill-health). The cap is adjusted according to the age at which compensation comes into payment;

  • Increases to pensions in payment are limited to 2.5 per cent Limited Price Indexation on post-1997 service. This is a lower rate of increase than the scheme was previously required to provide for post 97 service under the Pensions Act 1995, see Indexation, 14.8. It may also not reflect rights that the members had under the rules of the old scheme.

The Secretary of State and PPF Board have wide powers to change the compensation payable under the PPF by:

  • changing the percentages specified to calculate benefits (ie the 100 per cent and 90 per cent mentioned above); and

  • changing the revaluation rate for deferred benefits and/or the level of pension increases.

5.3 ITS v Hope: High Court rejects a cunning plan to protect pension scheme members

5.3.1 Summary

In Independent Trustee Services v Hope the High Court held that trustees may not arrange to seek to make a transfer out of a scheme before it entered the PPF with a view to getting better benefits for the transferring members than they would get under the PPF. Such a transfer would not reduce benefits for the remaining members (as the level of their PPF benefits would not be affected), but the court rules that such a transfer would not be for a proper purpose.

This judgment is likely to cause difficulties with many future actions of trustees and employers. They may need to be judged against a vague and uncertain 'proper purpose' test.

In Independent Trustee Services v Hope[10] , Henderson J, in the High Court, held that the trustees of the Ilford defined-benefit (DB) pension scheme could not seek to improve the position of some of the members by buying out part of their benefits with an insurer. The trustees were not allowed to take into account the potential protection of the Pension Protection Fund (PPF) when seeking to partially buy out benefits.

Broadly, the PPF can take over underfunded eligible DB pension schemes if the sponsoring employer has suffered a qualifying insolvency event. The PPF will then use the scheme's assets and its own assets (as a 'top-up') to compensate scheme members by providing benefits, but only up to a protected level. Generally, only members who have reached normal pension age (or retired early due to ill-health) will receive 100 per cent compensation – for further information see PPF protected benefits, 5.2)

Facts of the case

5.3.2 In this case the scheme was significantly underfunded, the employer was insolvent and the trustees intended to take steps later to cause the scheme to enter the PPF.

The trustees asked the court to rule on whether they could (in an extreme version of the proposal) use all the scheme's assets to buy out benefits for members who would have had a reduced and capped compensation.

This would have secured higher benefits for these members than they would have received under PPF compensation. But the buyout would leave no (or disproportionately reduced) assets in the scheme to secure benefits for members who had not been bought out.

In effect, the trustees were proposing this buy-out in the knowledge that once they had taken steps to transfer the scheme to the PPF, the PPF would need to use more of its own assets to protect members who had not been bought out. The buyout would cause a net higher cost for the PPF.

Decision

5.3.3 Henderson J held that the buyout was unlawful for the following main reasons.

  • The buyout would use a share of the assets that did not 'fairly represent' the benefits of the members bought out. It would consume a disproportionate amount of the scheme's assets, which (if the PPF did not exist) would prejudice members who had not been bought out. For this to be allowed under the scheme rules it would 'need the clearest possible justification, and equally clear language'.

  • The proposed buyout was a 'blatant attempt to undermine or circumvent the policy of the PPF legislation' and was 'inimical to public interest'. This was because the proposal sought to 'minimise, if not eliminate, the Scheme assets which will vest in the PPF, at a time when the Scheme is seriously underfunded'. Furthermore, the proposal treated 'the availability of PPF compensation as though it were an advantage to be exploited for the Scheme's benefit, whereas Parliament clearly intended the PPF to be a funder of last resort which will step in if, and to the extent that, the Scheme is unable to fund PPF level benefits with its own assets'.

  • The trustees did not have to consider the PPF's interest because it was not a contingent beneficiary of the scheme. But in light of the public interest argument it was a matter of law, in the context of the present case, that 'the prospective availability of compensation under the PPF, if and when the Scheme enters the PPF, is not a relevant factor for the Trustee to take into account' in the exercise of their discretionary powers and would not be relevant in 'any instance where trustees seek to take advantage of the existence of the PPF as a justification for acting in a way which would otherwise be improper'.

Comment

5.3.4 The facts of this case are unusual because the employer had become insolvent without triggering PPF protection and the trustees were the only creditors who had an interest in forcing a further insolvency event. This gave the trustees an unusual ability to control when the employer would suffer a 'qualifying insolvency event', without which the scheme could not enter the PPF. Therefore they had sufficient time to formulate a buy-out proposal before the qualifying insolvency event. Usually the employer itself or another contingent creditor would trigger the insolvency event, which would leave the trustees with insufficient time to formulate a buyout. The judge acknowledged that 'typically, a period of between 15 and 24 months is needed' for a buyout.

Standing back, it seems reasonable (as the judge decided) to protect the PPF in the specific circumstances of this case. Having said that, Henderson J was obviously struggling to find a legal way of reaching his decision. The members pointed out that parliament has enacted a range of protections for the PPF but did not think it necessary to block this route.

The problem with the judgment is that it raises many uncertainties. Henderson J wanted to deter any future attempt to 'take advantage of the existence of the PPF' and held that there was a 'principled basis upon which the court can intervene to nip behaviour of this kind in the bud'. So this decision could have wider relevance. For example, this case may prevent the trustees of a scheme that is funded below the PPF protected level from taking a 'Las Vegas gamble' by making high-risk investments knowing that even if the investments fail, the scheme members will still be protected up to the PPF level.

If this case has wider application, Henderson J's reliance on the 'public interest' arguments creates some uncertainty. It is not clear when this principle can be invoked in the future. For example, it may not always be clear when trustees are allowed to take the PPF into account when buying out benefits, allocating assets during a partial wind-up (eg if only some sections of the scheme are eligible for PPF entry), during a merger (trustees compare the PPF level before and after the merger), commuting pensions for cash or investing the scheme's assets. But this decision will probably not affect buy-ins, because a buy-in policy will still be an asset of the scheme that is available to the PPF.

An odd aspect of this case is that the judge did not explain why a different approach was adopted by the Court of Appeal in the earlier case of Easterly v Headway[11] [2009] (Henderson J did not even refer to this case). In Easterly, the Court of Appeal allowed a different cunning plan – that is, for the trustees to carry out a partial buy-out that increased the employer's liability to the scheme. Perhaps there may be less public interest in protecting an employer than in protecting the PPF? But it would have been better if the judgment in ITS v Hope had at least dealt with this.

The safest course of action for trustees will be to ask themselves whether it would be reasonable for them to make a particular decision even if the PPF did not exist. Trustees should carefully minute these decisions so that they can later prove that the PPF's existence was not a factor in their decision. If trustees cannot ignore the PPF's existence, they will need advice based on the specific facts of their situation.

In a more recent case, Dalriada Trustees Ltd v Faulds[12] Bean J followed a similar proper purpose approach to an investment power (this time to invalidate actions by trustees designed to get round tax rules).



[1] The Pension Protection Fund (Entry Rules) Regulations 2005, SI 2005/590 (the PPF Entry Rules Regulations).

[2] The 90 per cent and 100 per cent levels can be changed by regulations enacted by the Secretary of State.

[3] Initially £25,000pa. Usually increased each year. £29,897.42 (as at April 2011) after the 90 per cent has been applied.

[4] Initially £25,000pa. Usually increased each year. £29,897.42 (as at April 2011) after the 90 per cent has been applied.

[10] [2009] EWHC 2810 (Ch).

[11] Easterly Ltd v Headway plc [2009] EWCA Civ 793, [2010] ICR 153.

[12] [2011] EWHC 3391 (Ch).

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