New guidance on using guarantees to reduce Pension Protection Fund levies could lead some trustees to understate how much their guarantees are worth, according to Towers Watson. If that were to happen, it might help the PPF raise more through levies than the £630 million it has targeted for 2013/14.
The PPF’s guidance, published yesterday, maintains its threat that it will ‘in general’ reject guarantees altogether if it does not agree with trustees about how much these are worth.
Joanne Shepard, a senior consultant at Towers Watson, said: “The PPF thinks it needs an ‘all or nothing’ approach to valuing guarantees to avoid levypayers trying it on and seeing what they can get away with. The flip side is that trustees can either request a smaller levy reduction than they think they should be entitled to or risk ending up with nothing.
“The PPF acknowledges that its approach is ‘by no means a perfect one’ and says it will continue to look at how trustees can anticipate the strength it will attach to guarantors. In the meantime, it says it may partially recognise guarantees where ‘all the circumstances justify it’ but implies that this will be the exception rather than the rule.”
This stance may create problems for more trustees in 2013/14 than it did in 2012/13 because the PPF has changed its guidance to steer trustees towards more cautious assessments and no longer talks of giving trustees the ‘benefit of the doubt’. Some of the changes could lead to trustees needing to do more work to satisfy the PPF that their guarantee should be taken into account when determining the scheme’s levy.
Joanne Shepard said: “When designing a levy that it thought would raise £630 million in 2013/14, the PPF assumed that guarantees already in place would continue to reduce levies in the same way as before. If the new guidance persuades trustees to err on the side of caution when certifying how much these are worth, the PPF could raise more than it is officially targeting. It’s no secret that the PPF thinks that bigger deficits should lead to significantly higher levies but had to compromise on the revenue it is targeting next year, so perhaps it would not be too upset if the assumptions behind its £630 million estimate turn out to be undercooked.
“This follows a clampdown on guarantees which led to the levies collected in 2012/13 significantly exceeding the PPF’s expectations. The measures taken to date may mostly have affected guarantees that should not have been reducing levies in the first place, but the net could now be cast wider. The PPF faces a difficult balancing act in trying to give credit for guarantees where these reduce risk and to withhold it where they do not. Having been too soft in the past, the greater risk going forward is that it will be too tough.”
Guarantees and PPF levies
A pension scheme’s PPF levy depends partly on the perceived risk of its sponsoring employer becoming insolvent. PPF levies can be reduced where a stronger company associated with the scheme’s sponsoring employer guarantees that it will stand behind some of the scheme’s liabilities.
For 2012/13 levies, the PPF began requiring trustees to certify that they had no reason to believe that each guarantor could not meet its full commitment. This was to avoid levies being reduced by guarantees from companies with strong credit scores but small balance sheets. A sharp drop in the guarantees certified was cited by the PPF as the main reason why it now expects to raise £630 million in 2012/13 rather than the £550 million it originally budgeted for.
What did the PPF change yesterday?
Comparing yesterday’s guidance on guarantees in 2013/14 with that issued last year for 2012/13, the PPF has:
• Reiterated its policy that guarantees will in general be ‘wholly rejected even where the contingent asset may be considered to have some value’ if the PPF concludes the guarantor is not able to meet the full certified value of the guarantee (para 5.4.1). A new section says that trustees can avoid this by limiting the certified value to a level that the guarantor can ‘definitely afford’ (para 5.3.5), while an example encourages trustees to certify a guarantee at the bottom of the range of its possible value (para 5.2.18).
• Deleted an earlier statement that ‘a covenant review would not normally be required’ before trustees certify. (The policy statement published alongside the new guidance says that the PPF ‘did consider explicitly suggesting more widespread use of covenant reviews’ but thinks ‘it would be better simply to set out what trustees should consider rather than how that should be achieved’ (para 3.4.29).
• Stopped saying it ‘will not apply any discount to the net assets of guarantors in comparing them with the guarantee’. Instead, the PPF will consider ‘which assets of the guarantor are intangible or illiquid assets, and whether they can be realised for value’ (para 5.3.5).
• Removed a statement that it would ‘give the benefit of any doubt’ to trustees and challenge them only where the guarantor’s net assets are ‘somewhat below’ the sum guaranteed. Although this approach was initially linked to 2012/13 being the first year of the new regime, the PPF said in September that ‘we would expect to extend that approach to 2013/14’ (though it also said that there may be ‘somewhat less benefit of the doubt’ next year). The PPF ‘does not intend to provide further details about how it will select cases for further investigation of guarantor strength’ (para 5.3.4).
• Warned that: It is clear from our examination of contingent assets submitted for 2012/13 that, in certain instances, trustees have been prepared to knowingly certify – and therefore seek a reduced levy - when the guarantor would not be able to pay in the event of the failure of the employer (para 5.2.2). This suggests that the PPF believes there is a case for tougher rules/enforcement.
• Explicitly stated that in considering the strength of a guarantee, trustees must bear in mind that it would only be called upon following an insolvency event (para 5.1.3). This is not surprising given the PPF’s objectives but makes it clear that the trustees are expected to perform a more complicated assessment that takes account of future contingencies.
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