Back in the wild old days there were few protections for pension scheme members.
Long burnt into the public memory was the Maxwell pension scandal, for example, which saw around £400m of pension savers’ money plundered by a cash-starved newspaper mogul.
In the 1990s and early 2000s, greater consideration was given to protecting workers’ pensions. However it wasn’t until the Pension Protection Fund (PPF) arrived in 2005 that savers got bona fide protection.
Enter the PPF
The PPF – known colloquially as the ‘pensions lifeboat’ – was set up under the Pensions Act 2004 to protect people’s Defined Benefit (DB) pensions from being pilfered away.
The PPF has been a great success in preventing hundreds of thousands of people from losing their pensions when their companies went bust. Many big-name pension schemes have fallen into PPF over the years, including Carillion and Toys ‘R’ Us.
As of 2018, the PPF has picked up over 200,000 members and £30bn in assets under management.
How is the PPF funded?
Contrary to some righteous tabloid fury, the PPF is not funded by taxpayers. It is funded through a levy payable by almost all open DB schemes, and by investment returns on the assets it accepts.
That levy varies depending on how large and how risky a given pension scheme is. The largest, riskiest schemes pay the highest levy.
The levy is calculated in part every year, based on a valuation every three years (called the triennial ‘section 179 valuation’).1
Each year, the PPF issues a determination notice explaining how it will calculate the upcoming year’s levy. You need a brain the size of two watermelons to understand all the formulas.2
How do schemes fall into the PPF?
The starting point for entering the PPF is usually when the sponsoring employer (the company funding the scheme) thinks it’s on the verge of insolvency, or is insolvent.
It writes a polite letter to the PPF saying as much. How very British.
But insolvency alone doesn’t determine whether the scheme will go into the PPF.
First, the PPF starts an Assessment Period. This can take up to 18 months. During this time there are restrictions on the scheme (for example, no transfers out). In the background lots of smart finance people and lawyers look at how the pension scheme was funded (or not, as the case may be).
This Assessment Period culminates in what’s called a section 143 valuation.3 This valuation determines whether the scheme is ‘underfunded’ at the ‘PPF level’ or not.
A scheme will only transfer into the PPF if it does not have enough assets and money to pay for the same level of benefits that the PPF can provide (the aforementioned PPF level). It is deemed in this case to be ‘underfunded’.
If the scheme has enough assets to provide a benefit greater than the PPF compensation then instead the scheme must wind-up. It will normally seek a buyout from an insurer, which will provide the members a better deal than if the scheme fell into the PPF (sometimes called PPF+). The buyout process effectively sees the pension’s trustees hand the assets of the scheme over to the insurer. In exchange the insurer agrees to take on the liability of paying the scheme members their pensions.
Otherwise, where the scheme is underfunded, it falls into the PPF. The assets and liabilities of the scheme are again handed over by the pension trustees. This time the PPF takes control of the pension scheme and it pays out the scheme members’ pensions.
What happens to my pension if it goes into the PPF?
The PPF will pay you your pension if your scheme falls into its clutches.
The amount you get will probably be lower than if your scheme had not gone into the PPF.
The 90% level
There are two compensation levels: 100% and 90%.
If you have reached Normal Retirement Age (NRA) prior to the employer going insolvent then you get 100% of your benefits on the insolvency date. Your NRA depends on the rules of your pension (called the ‘scheme rules’). Usually the NRA is around 60-65.4
If you are younger than NRA, your pension payments are restricted to 90% of what you would have received.
A second way your pension can be reduced in the PPF regime is by the Compensation Cap.
If you are a 90% level member, your benefits are subject to a cap. The cap varies depending on your age. The PPF publishes the caps on its website, updating them yearly. For 2018, the cap is £39,006.18 per annum for a 65 year old.5
Increases may be restricted, too
A further reason your overall pension may be less than you expected is that the pension increases granted by the PPF are restricted. Let’s look at how this works.
With a DB pension, your benefit is built up – or in fancy pension language, accrued – each year you work. Depending on when you built up that pension, your pension is treated differently by law.
Someone who worked (and built up their pension) between 1985 and 1997 has their pension treated differently to someone who worked between 1997 and 2005. Your pension is split into blocks depending on when it was built up, and what law applies to it.
One of the legal provisions that differs between pension blocks is the rate of increase on your pension when it is paid.
When you take your pension (whenever that is) you should normally receive annual increases. These are designed to help your pension keep pace with inflation.
The minimum rate of these increases (if any) is set by law. The different rates for your pension blocks are illustrated below:
If your scheme goes into the PPF, the PPF pays your pension. Every year, while your pension is being paid, the part of your pension in the blue and red boxes in the diagram is increased by however much CPI has increased over the previous year (max 2.5%).6 Any other part of your pension isn’t increased (the green box).
For schemes that are not in the PPF, the increases you get each year depend on the scheme rules, but the minimum increases are shown in the diagram above. The scheme can be more generous.
You should be told what blocks your pension is split into and the rate of increases for each block in your benefit statements. If you don’t know ask your pension administrator.
As a result of all this, if your pension scheme goes into the PPF, it is entirely possible for your annual increase rate to go from 5% down to zero – for example, if you accrued all your pension before 1997.
About some fella named Hampshire
Due to the effects of compounding, this reduction in increases can significantly reduce the value of your pension pot. The reductions in benefits can also be substantial for high earners who have built up a very large pension and thus get hit by the cap.
One gentleman was particularly upset when his scheme fell into the PPF. Given he was looking at a two-thirds decrease in his payment, I’m not surprised! This chap took the PPF to court. In late 2018, the ECJ ruled that it was unlawful to have to have a reduction greater than 50% (Hampshire v PPF).
The result is that it appears there will now be a minimum guarantee of a 50% compensation level.
However it’s early days, and the full impact of the case may take some time to be clarified.
What can I do if my employer looks like it’s going bust?
Remember first that even if your employer goes bust, this might not mean your pension goes into the PPF. As we discussed above, the scheme may be sufficiently funded that the scheme must arrange a buyout instead. In that case, your payments will be better than you’d get in the PPF.
Unless you’ve got some magical pixie powers, you can’t stop your scheme sponsor going bust. You can though monitor the situation in advance. For example, you could sign up for notifications from Companies House and check the information produced by the pension scheme.
That said you are very unlikely to be able to do much pre-empting. The decisions around pension schemes are typically commercially sensitive and highly confidential.
You could potentially consider transferring out. However that’s a story for another time, and transfers out of a DB scheme should not be taken lightly.
Note you should be informed if there is an inkling that the scheme may fall into the PPF – because you must be told, by law.
Hopefully this short article has helped to provide a little bit of information around the Pension Protection Fund.
The PPF has provided much needed security for pension scheme members, including many who had saved all their working lives into their company schemes, only for their employer to teeter into insolvency.
For my money the PPF has been a great success!
- Have a look at a very helpful PPF welcome booklet on the PPF website.
Read all The Detail Man’s posts on Monevator.
- I know it’s a bit jargon-happy to refer to specific sections of the Pensions Act, but a pet peeve of mine is when different pension valuations are thrown around without context. We’ll see shortly why is important to differentiate between different valuations. [↩]
- Also known as being an actuary – I’m not jealous, really. [↩]
- Yes more jargon. A section 143 valuation uses a set of specific assumptions. Over time it’s become very similar to the section 179 valuation I mentioned in a previous footnote, but with a few specific differences. [↩]
- Likewise, if you have a widows’ or inherited pension the compensation level is 100%. [↩]
- Meaning a benefit cap of £35,106 per annum = £39,006 x 90%. [↩]
- That is, if inflation is more than 2.5% in a given year, you only get a 2.5% increase on your pension for that year. Conversely, if inflation is negative, your pension does not decrease. [↩]
Is there any protection scheme to cover defined contribution pensions? Or must we just hope that Scottish Widows, Vanguard etc. never follow in the footsteps of Equitable Life?
So glad PPF exists too.
I have a deferred DB pension from a previous employer and can’t touch it for 10 years so anything could happen to the employer in that time.
I just have a note of how much I should get if all is good and how much I should got if it falls into the PPF. That’s the best I can do and at least it is better than nothing.
An ex work colleague has enquired on the transfer value of their DB and has been bowled over by the amount and is looking to take the value, but I would rather stay with the DB option than transfer somewhere else. The guarantee is better than any DC projection that seems to head downward each year when I receive my annual statement, even though the value invested keeps going up. I will just continue to save into my SIPP and current employer DC pension to cover the bases.
“One gentleman was particularly upset that when his scheme fell into the PPF.”
@Charlie – Defined Contribution schemes are covered by the Financial Services Compensation Scheme (FSCS). You can read about the exact coverage here: https://www.fscs.org.uk/what-we-cover/
Generally speaking: DC schemes with an insurer are 100% covered. SIPPs are covered up to £50,000 per person per firm (depending on the exact arrangements). Annuities are 100% covered.
@Sparklebee – Sounds like you’ve got a good set-up with lots of options to cover your bases. I can sympathise with those offered enhanced transfer values – I’m sure they are very tempting. That said, a guarantee for life is very valuable. I’d venture we (as human beings) undervalue that future certainty. Though what the ‘right’ value is will depend person to person.
Thank you for this: very clear. One question that may loom larger for geezers than for young shavers: what about the widow’s pension? Am I right to believe that it’s 50% of the dead member’s pension irrespective of whether the widow was due more from the scheme?
I should clarify: I’m thinking of the case that the member dies while getting his pension from the PPF.
@TheDetailsMan – or anyone – for DC pension protection, what is meant by “with an insurer”? Does that include eg stakeholder pensions with the likes of Aviva or Legal&General? Even if invested in funds which the saver may or may not have chosen? I’ve never understood this. The nearest I found to guidance was on a government website which said that “most” such schemes would be covered… great….
50% vs 100% protection makes quite a difference!
hello, thanks for the article.
So what does this mean for someone saving into a SIPP? In a few years i hope to have more than £50k saved into index funds – if hargreaves lansdown etc. imploded would I only be compensated up to £50k? Or does the fact that i hold the underlying funds mean that I would just transfer them to another provider?
@dearieme – that’s correct. If you pass away whilst receiving your pension from the PPF your spouse will receive 50% of the pension going forward. That is even if your scheme was more generous.
@Haphazard – Please take the following with a huge health warning (as the government guidance is as clear as mud). My understanding is as follows. Say you have a stakeholder pension with Aviva, if it’s invested in Aviva managed funds you’re 100% covered if Aviva goes bust. If instead you are invested in externally managed funds (say with Vanguard), if Vanguard went bust you’d only be covered up to the £50,000 limit. In theory, if Vanguard went bust you’re money should be ringfenced (I say in theory because in practice things haven’t always worked out that way, for example, as with Beaufort Securities). You should still be 100% covered if Aviva went bust.
Here’s how I understand it for SIPPs. Say you have a SIPP with Aviva and it goes bust. You’d be covered up to £50,000. If the investment manager goes bust, you’re covered up to £50,000 per firm per person. If the bank that holds any cash goes bust, you’re covered up to £85,000 per bank per person. Though, as ever, I think it’s a little more complicated than that…
@factor – thank you for typo spotting. I’m absolutely sure it was an error introduced by my fantastic editor. I hope he will come along and correct his mistake when he has the chance 🙂
@thedetailsman – Does that mean that an 80 year old with a DB pension could marry a 21 year old and on death the younger widow would be legally entitled to 50% of the DB pension for the remainder of their life?! Might be one way to fund the cost of care in a later life!
@Goldenoldie – Afraid not. Most schemes have a ‘young spouse’s reduction’. It works a bit like this: for every year above an age gap of 10 years payment is reduced by 2.5% (the number of years and reduction depend on the scheme, but I understand those are the most common.) I imagine, though I’m not sure, that similar such rules would apply if your scheme fell into the PPF.
@Goldenoldie – it is quite interesting point, as this happened quite a bit the past. I believe the last surviving US civil war widow in receipt of a civil war widows pension only passed away only in the last decade or two. The result of an 80 year old veteran marrying an 18 year old girl who lived for another 70 years or so.
@thedetailsman @richardbrown would make for an interesting chat up line for someone in their latter years
Thanks @TDM, that’s something to ponder that I hadn’t thought of before.
One might assume, if a person’s projected DB payments were so high as to lose 50% to the cap, that they might have had some hand in actually steering that ship onto the rocks.
Btw (claim to fame), as an employee of Maxwell’s in the late 80s, I had to watch a video encouraging us to enroll in his pension scheme. I didn’t do it; I was saving up for a car (!) Friends did though, and eventually got some money back after a few years.
Can anybody clarify which, if any, guaranteed minimum pension (GMP) provisions apply to the PPF? I ask as the information I have found is not entirely clear to me and the figure above clearly shows that so-called “legal minimum” indexation (increases once pension starts being paid) does not apply to the PPF.
Also, I think it may be worth highlighting that as the PPF is not government backed:
The PPF can alter its levy to meet its liabilities. However, in extreme circumstances compensation could be reduced:
a) revaluation and indexation could be reduced by the PPF if circumstances required it;
and b) levels of compensation could be [further] reduced by the Secretary of State on the recommendation of the PPF.
Interesting article and comment.
I wonder if anyone can comment on the following:
I note the block period for pre and post 1997 increments regarding annual increases when pension is eventually paid. Can anyone clarify the deferred status of a DB pension. For example, A Pension was deferred in 1997, built up.from 1990. Value in 1997 was £5k. Under normal pension rules, the deferred pension would be evaluated before payment, that is 1990 to pension date, a period of 20 Years.of RPI increases. Am i right in thinking that there is no revaluation under ppf, and only annual increments for the period 1997 to 1999 are paid for subsequent Years ?
If thats right, i calculate I would loose 40%. My ex employer is not bust and hopefully wont
But it might help others to consider and maybe me.