The Pension Protection Fund (the "PPF") is seen as a lifeboat for members of final salary schemes where the employer is insolvent and can no longer fund the benefits due under the scheme.
At present members who have not reached normal pension age ("NPA") when their scheme enters a PPF assessment period get 90% of their basic accrued benefits while members beyond the NPA when the scheme enters a PPF assessment period get 100% of their basic pension.
Current PPF cap
The PPF then applies an overall cap for each member which limits the member's annual PPF compensation regardless of the benefits they accrued over the years under their scheme. The cap is reviewed regularly and from 1 April 2013 it has been £34,867.04 for individuals aged 65 or over (which equates to £31,380.34 for those who receive 90% compensation.
The compensation cap was introduced when the PPF was set up to limit its exposure and to introduce an element of 'moral hazard' for highly paid executives. However, following the collapse of the car parts company Visteon in 2009 there have been calls for a review of the way the PPF compensation cap is applied.
Many have argued that it unduly penalises loyal employees who remained in their scheme for decades thus accumulating significant pension entitlements. This was reflected in the Minister for Pensions' recent comment that:
" It cannot be right that someone who has been with a company for much of their working life – and relies heavily on that for their pension income – gets the same in compensation as someone with far shorter service and who could also have other pension income to fall back on."
The Minister for Pensions has announced a recommendation that members who have participated in the relevant scheme for more than 20 years will see the PPF compensation cap increase by 3% for every year of service in excess of 20 years' service.
For example:
- Mr Claus contributed to the Tinsel Pension Scheme for 40 years;
- He accrued benefits which would result in an annual pension of £50,000;
- After working very hard for many years Mr Claus put his feet up and celebrated his 60th birthday on 1 January 2010 and commenced receipt of his pension (£50,000 plus annual increases);
- The Tinsel Pension Scheme's employer, Sleighbells Limited, became insolvent and the scheme and subsequently entered into a PPF assessment period on 25 July 2013;
- The Tinsel Pension Scheme had insufficient funds to pay out all of its members' benefits on the PPF basis and subsequently entered the PPF. At this time Mr Claus was aged under 65 so was entitled to PPF compensation equal to 90% of his basic pension;
- Mr Claus' benefits were subject to the current PPF compensation cap so he has been in receipt of an annual capped pension of £31,380.34 and therefore under the new proposals he would receive an annual capped pension of approximately £45,000.
The maximum annual pension members who are subject to the revised cap can receive is approximately £63,000 so there is still provision in place to avoid highly paid executives emptying the coffers of the PPF. This is clearly a good result for earners with significant pension savings in one scheme which is at risk of (or is already) entering the PPF. Indeed, some may think all their Christmases have come at once.
There is, however, no such thing as a free Christmas lunch. Someone has to pay for it! The cost is to be absorbed by the PPF, ultimately meaning it will be passed on to the PPF Levy payers, namely employers sponsoring DB schemes.
Legislation has been promised to effect the increase in the compensation cap and we'll keep you updated via our ebulletins.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
