2nd November 2016 Anna Copestake in Lexis PSL Pensions on Pension protection levy – all change?
Pensions analysis: The Pension Protection Fund (PPF) has published a consultation document on the pension protection levy for 2017/18. Anna Copestake, senior associate at ARC Pensions Law, discusses the proposed changes and the likely impact.
PPF announces levy estimate for 2017/18, LNB News 23/09/2016 14
The PPF has published a consultation document which sets out the basis on which it proposes to charge the pension protection levy in 2017/18. The document also states that the amount that the PPF expects to collect in 2017/18—the levy estimate—will be set at £615m, unchanged from 2016/17. Any comments should be submitted to the PPF by 31 October 2016, and the PPF will publish its conclusions in December 2016.
What changes has the PPF proposed and why?
The consultation contains limited changes. The rules for 2017/18 will be substantially the same as for 2016/17, in line with the PPF’s goal of maintaining stability in the levy rules and levy calculation over a three-year period (or triennium). The levy estimate for 2017/18 is the same as for 2016/17, that being £615m.
Changes—impact of moving to Financial Reporting Standard 102 (FRS 102)
The most significant change relates to accounts filed for the first time under FRS 102, the new main standard under the Generally Accepted Accounting Practice in the UK (UK GAAP). This is an accounting standard effective for accounting periods commencing on or after 1 January 2015 and applies to entities not obliged to use International Financial Reporting Standards (IFRS). These are primarily unlisted entities.
Generally speaking, FRS 102 brings existing UK accounting standards more in line with IFRS, requiring entities to make a number of disclosure changes and some changes to how assets and liabilities are valued. One key area of change is around the valuation of defined benefit pension obligations.
The impact of this change on sponsors may be positive or negative. On one hand, there may be more scope to recognise pension scheme surplus on the balance sheet. On the other hand, there is no exemption for participating employers in multi-employer defined benefit (DB) schemes (under which they could account as if the scheme were defined contribution (DC) if their scheme asset share could not be determined) and instead, the employer may, if subject to deficit funding agreements, have to recognise DB assets and liabilities on the balance sheet for the first time. Further, interest income on scheme assets will no longer be calculated with reference to expected investment return. Instead, it will be calculated using the same rate used for the interest expense on scheme liabilities (typically high quality corporate bonds yields), which may result in a higher reported pension expense (or lower income) in the profit and loss (P&L) where the expected return on scheme assets is higher than that on high quality corporate bonds.
In turn, these accounting changes may affect the insolvency risk scores calculated by the PPF-specific insolvency risk scoring methodology, the pension protection score (PPS).
The PPF’s initial analysis indicated that a substantial majority of employers will be unaffected. A limited number may, however, see an improvement or worsening in their insolvency score (typically by one levy band). Such movement might be purely due to a change in accounting practice, not because of a better understanding of the employer’s financial strength. So to address this risk of artificial ratings movement, the PPF intends to introduce transitional measures.
To understand those measures it is worth recapping on how the insolvency risk score is awarded:
- Experian match the employer to one of eight ‘scorecards’ (ie categorisations of employer types)
- each scorecard consists of ‘change variables’ (eg data compared with information from an earlier year)
- in most cases the employer’s recently filed accounts are used to calculate a factor for each variable and these are combined to give a ‘monthly score’
- the 12 month average of monthly scores is used to match the employer with a levy band and a rate is then awarded
The PPF intends to allow employers on scorecards 1 (large and complex) and 8 (not-for-profit) to certify an adjustment to the figures in their accounts which are used to calculate the change variables. The PPF believes these scorecards are the only ones with variables (eg net worth) affected by the change of accounting standards, but asks stakeholders to flag if they think employers on other scorecards would move levy bands as a result of the change.
There is a draft certificate at the back of the consultation document and a worked example.
Changes—other limited changes
The consultation also includes changes around:
- the treatment of parent companies that file small companies accounts on a consolidated basis but are parents of employers
- the date from which Experian will use data when accounts are restated
- the scope of mortgage exclusions
- clarifying guidance in some areas eg expenses element for deficit-reduction contributions certification
Annuities in pension scheme accounts
Under the new accounting standard, schemes must include the value of annuities held in the name of the trustees in their accounts. This could lead to inconsistencies between accounts used for the asset breakdown and those underlying the last valuation obtained under section 179 of the Pensions Act 2004 (PA 2004). Like levy year 2016/17, the PPF will identify schemes with an asset breakdown date on or after 31 December 2015 and treat the proportion of ‘non-accounts insurance assets’ as zero. But for the 2017/18 levy year the scheme must have an accounting date for the purposes of PA 2004, s 179 before 31 December 2015.
Schemes do not need to take any action. In practice it means that the annuity value in the scheme accounts will only be used in PPF asset transformations until the scheme submits a s 179 valuation based on accounts prepared under the new accounting standard. Then asset transformations will revert to using the annuity value calculated as part of the s 179 valuation.
Reiteration of position where no ‘genuine’ sponsor
Where the sponsor is a shell or special purpose vehicle a claim on the PPF is only likely to arise when scheme funding deteriorates to such an extent that the scheme cannot continue to run. At this point ‘employer’ insolvency would be triggered. The PPF reiterates its previous commitment to ensure that the risk-based levy is calculated appropriately for schemes in this position.
In short, the PPF would focus on the level of scheme underfunding at which PPF entry would be triggered and the likelihood of that trigger level of underfunding being reached (which will be related to the investment strategy, that strategy effectively supporting the scheme).
Are there any proposed changes specifically in relation to contingent assets?
The consultation does confirm that the 2016/17 simplified recertification requirements for asset backed funding structures will continue for 2017/18. In most cases this means there is no need for new legal advice and a lighter touch valuation.
How might the changes affect UK pension schemes?
There may be an inadvertent change in levy band due to employers changing accounting standard. Employers will want to check with their advisers whether they are affected. If so, employers (and trustees) will want to establish whether it is worth certifying adjustments. In which case, relevant information will need to be gathered to enable them to make the certification.
Helpfully, the PPF intend to add functionality to the online portal to help levy payers understand if they are affected by the change in accounting standard and whether reporting any adjustment would move them a levy band.
What happens next?
The consultation closes on 31 October 2016. The PPF will publish their conclusions before the end of the year.
Over the next triennium (2018/19–2020/21) the PPF will review more significant elements of the risk-based levy calculation, including the PPS. An update on what the PPF plans to review in the third triennium is on their website.
Detailed proposals for the triennium for consultation will be published around the end of the year, and consultation on the detailed levy rules will follow by autumn 2017.
Interviewed by Evelyn Reid.
Read the full article on Lexis Nexis PSL Pensions here.
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. ARC Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.