Default trends among UK companies suggest that the UK Pension Protection Fund (PPF) could rapidly exhaust its resources in meeting claims from company pension schemes, according to a new study by Standard & Poor’s, the ratings agency.
Under current proposals, the PPF – which has been established to compensate members of defined benefit pension schemes which are in deficit when their sponsors default – will be funded by a levy of £300 million ($567 million) a year from April 2006. However, Standard & Poor’s analysis of historic default trends among UK companies shows that – even on relatively optimistic assumptions – annual claims on the PPF would substantially exceed £300 million. A full copy of the study is attached.
“If past experience is anything to go on, there is a real risk of the PPF accumulating a sizeable deficit of its own quite quickly,” said Jim MacLachlan, director of European pension services at Standard & Poor’s. “Although corporate default are currently at a low ebb, it is likely that the annual levy will have to increase significantly in the early years. That may pose its own problems, as schemes under the new regulatory regime have to simultaneously trim their own deficits and pay a higher contribution to the PPF. There is a danger they will be squeezed at both ends.”
Standard & Poor’s study is based on the rate of default since 1981 of companies with different credit ratings. It applies these risk probabilities to the largest 340 UK corporate and financial sector pension schemes – which account for around 65% of pension scheme assets and deficits. Average scheme deficits for these companies are extrapolated to the other 5,000+ smaller defined benefit schemes, where default risk is much higher. The analysis also illustrates the impact that changes in the amount of pension assets recovered following insolvency has on the loss experienced by the PPF.
On the most optimistic scenario that schemes will recover 40% of the deficit from their defaulted sponsor, the annual claim on the PPF would be £670 million, more than double the annual levy to the fund. If the recovery rate was only 20% – a more realistic level for schemes outside the top 340 – the PPF would have to pay out around £890 million a year, compared to a £300 million inflow.
If the worst five year period since 1981 for corporate defaults was repeated, the annual call on the PPF would be between £940 million (assuming a 40% recovery rate) and £1.57 billion (at a 20% recovery rate).
“While the PPF is not required to be solvent in the sense of an insurance company, there must be a limit to the losses it can shoulder without additional funding,” Mr MacLachlan noted. “The experience of the PBGC in the US has shown the speed and extent with which funds can be hit.”
