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How can contingent assets reduce the PPF levy?

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The levy imposed by the Pension Protection Fund (the PPF) can be costly for employers of defined benefit (DB) schemes, especially in respect of schemes that are already underfunded. Contingent assets can be an attractive option to reduce the levy.

What is the PPF levy?

The PPF levy is made is up of two components - the “scheme-based” levy and the “risk-based” levy. The scheme-based levy is calculated based on the liabilities of the scheme and must be paid by DB schemes.  As its name suggests, the level of the risk based levy depends on the likelihood of the scheme being unable to pay its pension obligations and therefore the risk of the scheme entering the PPF.  This element of the levy takes into account investment risk taken by the scheme, the level of scheme funding, and the likelihood of the sponsoring employer(s) becoming insolvent.

How can the risk-based levy be reduced?

One way to reduce the levy is to put in place a PPF-compliant contingent asset in favour of the scheme.  Broadly, there are three types of contingent assets recognised by the PPF:
1.     Type A contingent assets are guarantees from a parent or group company.  The guarantee can be called upon by the Trustee if an employer defaults on making a payment to the scheme, including if an insolvency event occurs in relation to the employer which causes a payment to become due to the scheme under section 75 of the Pensions Act 1995.

2.     Type B contingent assets are security agreements where security is granted to the scheme over cash, real estate or securities.  This type of contingent asset typically utilises assets the employer already has and provides recourse for the Trustee to those assets if the security becomes enforceable, for example in the event of an employer insolvency.

3.     Type C contingent assets are letters of credit (issued by banks) or surety bonds (issued by insurers). In certain circumstances such as non-payment by, or the insolvency of, an employer, the Trustee can make a demand on the bank or insurer to pay amounts covered by the contingent asset.

What are the requirements?

Each year the PPF publishes guidance in relation to the contingent assets referred to above.  If the PPF is to recognise a contingent asset for the purpose of reducing the risk-based levy, a number of requirements must be satisfied and the contingent asset must be certified with the PPF.  Some important points to note are:

·       Standard forms - the contingent asset must be in the PPF standard form and any changes to this form must not be materially detrimental to the Trustee.  Each change should be considered in isolation rather than considering the combined effect of the amendments.
·       PPF deadline – there is a hard deadline at the end of March every year for contingent assets to be certified with the PPF.  It is crucial that this deadline is met if the contingent asset is to be recognised for levy reduction purposes for the upcoming levy year (which starts on 1 April).  If the deadline is missed, the scheme will still benefit from the contingent asset, but no levy reduction can be obtained for that levy year.

Are PPF contingent assets right for my scheme?

The PPF requirements for contingent assets are fairly stringent and may not be suitable or appropriate for all schemes.  With that being said, contingent assets that do not satisfy the PPF requirements can be of benefit for schemes and employers even without the levy reduction.
Paige Willis, Associate at Sackers