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back to index backEUROtalk October,  2005

UK: Large Premium Increases on Company Pension Plans Lie Ahead

Employers with defined benefit plans are facing massive premium increases next year when the risk-based levy required by the Pensions Act of 2004 goes into effect. The new premiums are payable to the Pension Protection Fund (PPF) beginning in April 2006.

A recent government consultation document setting out the rationale and methodology for the new levy suggests that it could range on average from £320 (US$587, €474) to as high as £30,000 per £1 million of liabilities, depending on the risk assessment of each company's pension plan. It is also generally believed that these figures understate the amount that the PPF will have to collect. The consultation (public comment) period ends on October 4, 2005.

Levy Structure

By law, the new premium structure applies to all defined benefit plans and is intended to be sufficient to fund the benefit claims on the PPF from underfunded plans that terminate due to employer insolvency. The governing board of the PPF will estimate this funding requirement based on actual experience on an annual basis and is expected to publish its first estimate by the end of November.

The levy will comprise two elements, a plan-based levy and a risk-based levy:

The plan-based levy will be a percentage of the plan liabilities that the PPF would take over. The current levy is based on the number of plan participants only. For the financial year beginning April 1, 2006, this will make up 20% of the total amount collected by the PPF.

The risk-based levy will account for the remaining 80% and will be based on two factors:

- The plan's level of underfunding, determined by measuring the difference between the value of assets and PPF liabilities. This must be carried out using prescribed assumptions, with the value of the PPF liabilities equal to the cost of the benefits that the PPF would provide (which is less than the total benefits). If a PPF valuation is not completed by the end of this year, then funding figures (based on the U.K.'s minimum funding requirement) from the plan's lastvaluation, with adjustments, will be used to calculate the levy the following year.

- The one-year probability of the sponsoring employer's becoming insolvent. The PPF board has appointed Dunn and Bradstreet (D&B) to perform the assessments. We understand that each employer will be assigned a D&B failure score” that will be used to determine placement in one of 10 insolvency risk bands that will be created by the PPF.

There is particular concern that, with multi-employer plans, which are common in the U.K., the PPF board's stated approach in assessing employer risk will only look at the employer with the highest number of plan participants. If the employer faces a higher risk of insolvency than other companies in the plan, this could lead to a higher risk-based levy for all plan members. Of even greater concern is that, if the plan sponsor is a U.K. subsidiary of an overseas company, the financial strength of the parent company may have little influence on the assessment. We are already aware of one group of subsidiaries of a common U.S. parent that could have widely different failure scores if they were rated individually under the proposed system.

Implications for Employers

Once the levy structure has been finalized, employers will need to consider what action they may wish to take to reduce the amount that they have to pay.

- Can they reduce their risk rating? For example, there may be implied support for the plan from within a group of companies that is not picked up in the risk rating. If so, there may be action that will improve the rating. Shifting jobs into a better-rated entity is one possibility.

- Would a PPF valuation produce a smaller underfunding position? Unless a new PPF valuation is completed by

December 2005, an adjusted position from the last valuation will be used for next year's levy. This may produce a less favorable financial result. For example, it appears that no account will be taken of any additional contributions made to the plan to correct underfunding.

- Should a company pay additional contributions to improve the funding position? In addition, we are aware of employers considering collateralized guarantees or third-party insurance as a substitute for direct cash payments.

Such arrangements will, we understand, not be recognized by the PPF when calculating the 2006/07 levy.

In practice, individual sponsors can seek only to reduce their share of the levy. The total amount collected by the government will be driven by plans' collective actions and actual events.

Source: Towers Perrin - GAI

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