Pension Protection Fund and Occupational Pension Schemes (Levy Ceiling) (No. 2) Order 2023

Motion to Take Note

Moved by

That the Grand Committee takes note of the Pension Protection Fund and Occupational Pension Schemes (Levy Ceiling) (No. 2) Order 2023, given the impact of current increases in the cost of living on pensions payable by the Pension Protection Fund.

My Lords, this order is routine and has little practical impact on the PPF. The levy that is currently payable is only 16% of the cap set by the order. However, having it before us provides an opportunity to discuss the operation of what is becoming—a bit under the radar—one of the country’s biggest financial institutions.

I have a particular interest as I like to think that the PPF, or at least the name, was my idea. Back in 1995, following the Maxwell scandal, I drafted a paper for the TUC that proposed, among other things, that there should be a central discontinuance fund that should be called—wait for it—the Pensions Protection Fund, or PPF. Of course, the proposal was not accepted at that time, but it was introduced subsequently in the Pensions Act 2004.

Before getting to the focus of my speech, I have a couple of questions. First, the Minister should provide the Committee with some explanation of the error that was made with this order. I am not trying to embarrass anyone, but it surely suggests excessive pressure on DWP staff, so the question is: has the situation been rectified?

Secondly, as was raised in the 30th report from the Secondary Legislation Scrutiny Committee, can the Minister tell us where we have got to in following the recommendations in the departmental review? I will highlight two recommendations from the review. First, recommendation 2 is that

“the DWP and the PPF work together to understand the implications of the PPF’s funding position in light of expected future developments in the population of Defined Benefit (DB) pension schemes and plan well ahead for any legislative changes that might be needed; for example, to address what happens to any funding which is surplus to requirements”.

It is worth noting that the current legislation says nothing about what should happen to any assets that, in the event, are not needed to pay members’ benefits. Given the PPF’s policy of building up a substantial buffer that, even on its own figures, is unlikely to be needed, the question needs to be addressed.

Any money that is left over cannot go back to the employers, because things will have moved on and employers will have moved on. It also seems wrong that it should go to the Government. The only just solution is for it to be used, as far as possible, to provide benefits for members. In practice, this means that the buffer should not be excessive. In these circumstances, where there is no residual legatee, bigger is not necessarily better. It might be unjust, and its level therefore becomes not just a technical issue but an issue of fairness to members.

Recommendation 6 states:

“The PPF should consider how the Board could hear more directly about the member perspective to inform its deliberations”.

My Lords, the PPF provides real support to some 295,000 pension scheme members who have entered it, including through the £1.1 billion paid out in compensation each year. It provides security to those in current DB schemes who may need to call on it in future. Add to those figures the Financial Assistance Scheme, which covers a further 150,000 members and, following the Pensions Act 2004, is administered by but not funded through the PPF, and we are providing a blanket of considerable security to heading for half a million people.

It is very important to remember that, before the 2004 Act, members could lose all or much of their pension savings when employers became insolvent or simply walked away from their liabilities. When the Labour Government created the PPF, there were many doomsayers who predicted that it would not be sustainable. In fact, the PPF has defied those doubters: it is financially resilient, has been well run, and has weathered the various economic storms that have occurred over the past 15 years.

However, the financial resilience of the PPF over the very long term still needs careful consideration. I probably take more comfort from the cosiness of prudence than my noble friend does, but the past few years have seen a significant improvement in overall scheme funding through increased employer contributions, rising interest rates and, more recently, rising gilt yields. I acknowledge that, but there is always the risk of the economic environment worsening and future large claims on the PPF. There will be a decline in the number of PPF levy payers resulting from schemes transferring into the PPF, and the number of schemes likely to buy out with an insurance company. Schemes underfunding is one of the biggest risks that the PPF faces, and there are still scenarios in which scheme funding could deteriorate. We have seen rapid movements in the level of scheme funding. What we have witnessed over the past 15 years confirms that.

The funding regime for the remaining open schemes is also important. Many of the larger such DB schemes have considerable deficits on a Section 179 basis—that is, the basis for funding to provide a PPF level of benefits. The Purple Book shows that open schemes are around 20% worse funded than closed schemes, on a Section 179 PPF benefits level basis. Such schemes presenting to the PPF could have a significant impact on the PPF’s funding, if they made a claim. There is also a long tail of small schemes which, together with stress schemes, collectively constitute, as I understand it, over one-third of the remaining 5,100 DB schemes. The estimates suggest that the annual capacity of the buy-out market is £50 billion to £100 billion, but it is likely to be the stronger schemes that buy out, with the less financially resilient schemes left in the PPF universe.

I mention all those things because, although the PPF is resilient when looked at today, we know that the risks that it has to be embrace and deal with can move against it. What work is being done to assess the impact and extent of a future decline in the number of levy players and the implications for the annual levy and the financial resilience of the PPF? In the light of the PPF’s current improved resilience, I understand that the DWP and the PPF are jointly considering the potential for more flexibility in setting the levy. Is the Minister able to report on when we are likely to know the outcome of those deliberations?

Improved PPF financial resilience, against a background of current high inflation levels, is bound to raise questions about current compensation levels paid to scheme members who entered the PPF. Looked at over the long term, an important part of maintaining the financial resilience of the PPF and the fairness towards levy payers has been the level at which PPF compensation payments are set. As my noble friend spelled out, current compensation payments are inflation indexed only on pension benefits accrued since 1997, not on benefits accrued before then, and the index is capped at 2.5%.

Understandably my noble friend is concerned that, in the face of high inflation and its impact on members of the PPF, the annual levy for 2023 is being reduced to 16% of the levy ceiling, given that there are some strong arguments for saying that the level of compensation payments should be improved. Again, I go back to my natural affection for prudence. Changing the PPF compensation levels, specifically to provide improved inflation indexing, would have a material financial impact on the PPF and wider implications for DB schemes, and, by association, the funding of the Financial Assistance Scheme. Changes to indexing would need consideration of the level of increase on the PPF’s future liabilities and the impact on the number and size of claims that the PPF would receive in the future, and it would almost certainly raise arguments about the cost of backdating any index payments.

We would also have to deal with schemes that had wound up outside the PPF through buyout at a level of benefit above current PPF benefits but which, if compensation payments are increased, would have been better off if they had transferred into the PPF. More schemes will become underfunded on a Section 179 basis. In looking at ways in which compensation could be improved, particularly for benefits accrued prior to 1997—I am hesitating on my memory—there are some quite serious issues to reflect on.

I am aware that the Work and Pensions Committee is looking at the system and the level of PPF compensation. Without treading on its toes, I ask the Minister whether there are any plans to increase the transparency of reporting on the department’s consideration of the annual levy raised, and about the scope for increasing the level of compensation to members in a high-inflation environment, and the need to ensure financial resilience of the PPF in the face of other risks evolving over time.

The other issue is that the PPF will be entering its own maturing phase, which will require it to have a greater focus on maintaining financial resilience. Reading the various papers that we had before us, I did wonder whether, in those circumstances, the PPF is right to decide to build reserves at a significantly slower pace than it had been building them. Certainly, in the DB scheme world, the regulator often encourages DB schemes to get assets in while the covenant is strong, and not wait until it is weak and seek the money. I wondered whether it is such a good idea to slow down the building at pace of reserves.

Finally, is it possible to update the Committee on the DWP’s view on the maturing of the PPF, which is a kind of shift in its position? I appreciate that it may not be possible to make a verbal response to that, but a written response would be helpful.

My Lords, I congratulate the noble Lord, Lord Davies, on securing this debate; it is an important one. At the outset, I say that I believe that the Pension Protection Fund has done and is doing an excellent job, and member experience in the PPF seems to be very positive—for me, that is one of the big tests of whether this is working well. The administration is very efficient, and the amount of compensation being paid is reaching those who need it, and are entitled to it, well.

I also congratulate the noble Lord on his foresight in 1995. I recall first becoming involved with Allied Steel and Wire and the various other pension schemes whose members had lost their entire pension very close to the point at which they were expecting to start receiving it, together with all their other life private savings —in those days, if you wanted to have any extra pension contributions you had to put all of it into your employer’s pension scheme. I remember reading about the proposals for a central discontinuance fund and thinking, “If only”. It informed my conversations with the No. 10 Policy Unit, the Treasury and the economic advisers to the Prime Minister at the time as to which way we needed to go to improve the situation the country faced. Over the subsequent two to three years, more and more pension schemes failed, and more and more members started losing their pensions; it was a serious and heartbreaking time. Members, having been told that they were fully protected, would have expected that all their money was safe. They were told that, regardless of what happened to their employer, their money was safe and that their pension was protected—but it turned out not to be the case.

Instead of the proposal from the noble Lord, Lord Davies, of a central discontinuance fund, we got the actuarial profession’s minimum funding requirement. Unbeknown to members—and, indeed, to most pension professionals outside actuarial circles—that was designed to deliver only a 50:50 chance of people receiving their full pensions, and yet members, trustees and employers were told that, on that basis, their fund was fully funded or in surplus. Unfortunately, what happened subsequently, around the end of the 1990s, with the market crash, was that those surpluses melted away. It looked as though the benefits had been secure but, suddenly, the market crash made that position unsafe. We saw that those so-called surpluses were in fact buffers against bad markets, rather than real surpluses—you could judge that only with hindsight in the end.

Finally, to pick up on the remarks of the noble Lord, Lord Davies, on the arbitrary and unfair treatment of pre-1997 members, that applies particularly strongly to members in the Financial Assistance Scheme. This scheme is not funded by all other pension schemes or employers; it is a part of government spending. Members in the Financial Assistance Scheme were never told that there was a Pension Protection Fund that would reduce their pension when they reached retirement; they were always told that their pension was completely “safe and protected by law”, to cite government documents sent to them at the time. They would be particularly at risk, because their schemes failed before the schemes that belonged to the PPF. They would be at risk of losing more because, by definition, they had more pre-1997 benefits.

May I put in a plea? Given that the Financial Assistance Scheme’s membership is more than half the size of the membership of the PPF, if there were any consideration of increasing the generosity of inflation protection for members of the Pension Protection Fund, even on a one-year basis, for example could that be applied to the Financial Assistance Scheme as well? It would be an option to offer them extra on a temporary period. On that basis, does my noble friend know, or will he write to me about, how much extra money the Government have so far added to the assets that were gathered in from Financial Assistance Scheme schemes to supplement the amounts paid out for members of those schemes?