Under the proposals, the risk-based levy will be calculated by combining the short-term risk rate, short-term underfunding values and short-term insolvency probability. Each measure also has a five-year equivalent.
Showing support for the plans, Milan Makhecha, consultant and actuary at Aon Consulting, said: “This approach will correct the injustice caused by the current, simple levy structure, meaning schemes pay levies that are more aligned to the long-term risks they pose to the PPF.”
However, Keith Webster, pensions partner at CMS Cameron McKenna, said the more complex calculation will cost the PPF significant amounts of money, which will ultimately be passed onto the schemes.
“The PPF is in a tricky situation. There is a feeling that the good schemes are funding the poor schemes, but if it turns that on its head and forces the poor schemes to pay more, it would be criticised for pushing schemes already feeling financial pressure even closer to the PPF,” Webster said.
“The proposals seem to be trying to look at individual scheme characteristics in more detail, but in doing so they don’t look at the current administration problems, which will only become more difficult with the more complex calculations being proposed.”
John Ball, head of defined benefit consulting at Watson Wyatt, also questioned how qualified the PPF was in defining levels of risk. “Charging schemes according to how ‘risky’ their asset allocation is may sound like the right thing to do, but is easier said than done. It is too simple to say that bonds are low risk if a scheme invests in short-dated bonds that are not linked to inflation when its liabilities are long-term and inflation-linked,” he said.
“The PPF understands this but does not yet have the data to take account of investment risk in a more sophisticated way. There are considerable practical hurdles to clear before this change could be implemented.”
Charlie Kirby
THE NEW CALCULATION
The proposed risk-based levy (RBL) can be expressed by the following formula:
RBL = c x U x P + w x QXV
Where:
- P is the scheme’s one-year insolvency probability;
- Q is the scheme’s conditional five-year cumulative insolvency probability;
- U is the one-year measure of underfunding;
- V is a conditional measure of underfunding; what level would the scheme be funded if it is part of an ‘unexpected claim’ over five years;
- c is the rate for short-term risk;
- w is the rate for long-term risk.
