UK - The National Audit Office (NAO) has commended the Pension Protection Fund (PPF) for retaining a healthy balance sheet during the recession, but warned it needs to take steps to manage its increasing assets efficiently and perhaps adapt its investment processes.

In a report reviewing the PPF’s management of its assets and the risks posed by potential future liabilities, the NAO found the organisation had not been exposed to “severe losses” as a result of the stock market decline during the UK recession.

It said the fund’s investments as a whole returned 13.4% in 2008-09, driven primarily by gains from interest rate and inflation swaps. The 16.8% return from swaps helped offset the -3.4% return on its standard investment strategy. The PPF invested 70% in bonds and cash and the remainder in equities, property and other growth assets.

Despite this, the report noted: “As the fund’s assets grow in size and complexity, the investment operation will require additional skills and more developed processes for managing and monitoring its external investment managers.” The NAO added the PPF “should consider adapting its investment processes”.

Research into the PPF’s ability to assess risks posed by potential future liabilities concluded the organisation’s long-term risk model had proved resilient, but the NAO recommended the introduction of a formal framework explaining the effects of certain assumptions regarding scheme closures or changes to investment strategies.

Other recommendations included a review of the role and responsibilities of the investment and asset and liability committees, and further development in the handling of managers and analysing performance.

The report noted the PPF’s deficit had already increased from £500m (€573m) in March 2008 to £1.2bn a year later and said this “could grow further if more firms become insolvent and the fund takes over underfunded schemes”. That said, the NAO admitted the PPF’s median risk-model projects the deficit falling to zero by 2013.

It highlighted actions already taken by the PPF to minimise the risks of potential liabilities including the work of the recoveries team to help diminish a scheme’s deficit by acting as a creditor for the pension fund. It is estimated the PPF has recovered nearly £73m by acting as a creditor, with a further £194m believed to be due from dividends.

The NAO meanwhile noted that in some circumstances the PPF can participate in the restructuring of an insolvent company to secure better assets on behalf of the scheme - a move which effectively sees the PPF invest in a company to try and prevent a company from collapsing completely. The PPF has so far been involved in 29 restructuring deals, and it now has equity holdings in 13 companies, generating a gain to the PPF of £365m.

One such example relates to the Sheffield Forgemasters Pension Scheme where participating in a rescue deal allowed the PPF to receive a cash contribution of £1.3m and a 26% equity stake in the new company which sold for £1.7m. This saw the PPF triple the amount of assets secured for the pension fund, rather than the sum it would have held had the PPF let the company become insolvent.

The PPF said while this is something it has always considered as part of the recoveries process, it will only enter into this type of agreement under certain conditions where insolvency is inevitable and a deal can secure more assets for the scheme than the normal insolvency process.

Amyas Morse, head of the NAO, said: “The PPF has done well to retain a healthy balance sheet in trying economic times. However, it is likely that the challenge facing the fund will increase as more schemes are transferred to it. Therefore, it should continue to take appropriate steps to manage the increasing value of its assets efficiently and continue to work at improving its ability to assess the risks that it faces in periods of economic difficulty.”

In response to the report, Alan Rubenstein, chief executive of the PPF, said the organisation has strived to balance the need of providing protection to pension scheme members with making sure the levy remains affordable and fair. He claimed the report showed it had achieved that balance by “investing efficiently and having assessed and responded to the potential impact of future claims on the PPF”.

He continued: “The report does make a number of recommendations which are aimed at making sure we continue to provide value for money. I am very pleased to be able to say that we already have plans and processes in place which will enable us to carry out these recommendations quickly and in full.”

The PPF is currently reviewing its Statement of Investment principles (SIP) and plans to announce a new one in the near future, while it is also “looking at reviewing our whole investment strategy” with an update expected later in the year.

Most recently, the PPF appointed seven global equity managers to prepare for an expected growth in assets. (See earlier IPE article: PPF appoints global equity managers)

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