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The UK’s Pension Protection Fund (PPF) has proposed a new levy for pension schemes without a “substantive” sponsor.

It is consulting on its proposal, in line with plans it set out late last year.

The introduction of a levy for schemes operated by standalone pension funds could be significant if it paves the way for schemes like the British Steel Pension Scheme (BSPS) to run without a sponsor but still be eligible for PPF coverage. The PPF takes over defined benefit (DB) pension schemes when their sponsoring employer becomes insolvent, and it charges a levy to DB funds to help fund its operations.

Introducing the consultation document, David Taylor, general counsel at the PPF, said that the lifeboat fund was proposing to base its charging methodology on “a commonly used pricing model for assessing put options”.

He said this is because the PPF’s standard approach, which is centred on assessing the likelihood of a sponsoring employer becoming insolvent, is not suitable for schemes without a substantive sponsor.

The primary risk posed to PPF levy payers from these schemes was the risk of failure in a scheme’s investment strategy, according to the PPF.

“For a scheme without a substantive sponsor a claim on the PPF requires only a deterioration of the scheme’s funding position,” said Taylor.

Put options are the “financial instrument most closely comparable to the risk presented to the PPF’s levy payers by a scheme without a substantive sponsor,” wrote Taylor.

Two principles underpin the PPF’s proposed charging methodology.

The first is that the resulting levy should be “fair”, in that it does not contain “an in-built cross subsidy from or to other schemes”.

A second key principle is that a scheme without a substantive sponsor “will always pose a higher risk than an otherwise identical scheme with a continuing sponsor, however weak”.

Under the PPF’s proposal, such a scheme will therefore always be charged as a minimum the amount that would be due under its standard rules for levy charging.

‘Complex’ area

The PPF emphasised that “this is a complex area, in which experience of specific propositions may evolve over time”.

The consultation coincided with the UK government’s wide-ranging green paper published yesterday regarding on defined benefit (DB) pension reform.  

The PPF said any new rules would be effective for 2017/2018, and would be limited to schemes that run on without sponsors as a result of arrangements put in place after the start of the 2017 calendar year. It added that it may have to develop its approach in response to experience of operating the rule or government policy.

The PPF said it does not expect the new rule to be needed widely, and that there may end up being no schemes charged on this basis for 2017/18.

“However, we consider it appropriate to have a rule in place in case it is needed – rather than risk an effective cross-subsidy from existing levy payers – and in order to provide clarity and transparency on our approach in the event such an arrangement is being contemplated,” wrote Taylor.

BSPS is in negotiations with its current sponsor, Tata Steel UK, the Pensions Regulator, and the PPF about separating the link between scheme and sponsor. Tata claims the ongoing costs of the DB scheme could push it into bankruptcy, while BSPS believes it has sufficient assets and investment strategy to survive outside of the PPF.

The consultation is open until 6 March and the PPF will publish final rules by the end of March.

The consultation document can be found here.

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