New analysis from consultants LCP shows that the PPF is likely to face a multi-billion pound hit as a result of insolvencies in the wake of the Covid-19 crisis. But the report finds that the flexibilities built in to the PPF funding structure should be enough to withstand all but the deepest crisis without the need for extreme measures such as cutting PPF benefits across the board.

The new report: “The PPF and Covid-19 – Can the lifeboat sail to calmer waters?” starts by looking at the last twelve years of claims on the PPF since the Global Financial Crisis.

In the first six years after the crash (from 2007/08 to 2012/13) there were an average of over 100 new claims on the PPF each year with an aggregate impact on the PPF’s deficit of £3.7bn. Perhaps surprisingly, in the ‘business as usual’ period from 2013/14 to 2018/19, although the number of claims was much lower – an average of around 50 per year – the total hit was higher – around £4.5bn. This was primarily due to the impact of one large scheme – Kodak Pension Plan No. 2 – entering the PPF during the latter period, which accounted for around one third of the total. This demonstrates that it is not the total number of insolvencies which is key, but rather the extent to which those insolvencies are concentrated amongst firms with larger deficits.

Given the severity of the current economic crisis, the report then models two scenarios for the coming years – a £10bn hit on the PPF and a £20bn hit. The £10bn scenario (“insolvencies double”) assumes a similar rate of insolvencies as followed the 2008 crash, but based on more recent claim levels. The £20bn scenario (“deeper downturn”) reflects a slower recovery where PPF claims are focused on companies with larger deficits.

LCP warns that the biggest risk to the PPF would come if the current crisis hit sectors of the economy which tended to have relatively large DB deficits. The report finds that around one quarter of the FTSE 350 comprises firms in the most ‘at risk’ sectors in the current crisis, including hospitality and entertainment, manufacturing, aerospace and high street retail. In some cases these are also sectors with long-established employers with large DB schemes. If several of these larger employers were all to face insolvency in the coming years, even the more serious £20bn hit could prove to be an under-estimate.

Whilst even a £10bn hit would be large by historical standards, the report points out that the PPF has several ‘levers’ it can pull in order to absorb even a relatively large series of additional liabilities. These include:

• Putting back the date at which PPF is targeting ‘self-sufficiency’ – this would allow the PPF to go on investing in growth-seeking assets for longer, and could also see significant levies in place for longer and would reduce the need to rely exclusively on levy increases
• Accepting a lower target probability of achieving ‘self-sufficiency’ – PPF reports that its probability of being self-sufficient by 2030 dropped from 91% to 89% between 2017/18 and 2018/19, mainly because of the impact of one large insolvency; it chose to allow the probability of hitting its target to fall slightly rather than pull other ‘levers’ to get funding back on the original track
• Raising levies – PPF currently raises around £600m from levies on DB pension schemes; the current plan is to reduce levy income over the coming decade; but instead, levies could be maintained or increased; there is a legal limit of 25% on levy increases from one year to the next but the statutory ‘levy ceiling’ set by Parliament would allow the PPF to almost double levies over time if it wished;
• Changing investments – PPF could seek higher investment returns through taking on higher risk. Whilst this increases the chances of a negative outcome and having to pull other levers harder, if things go well this could avoid the need for other, less palatable options;
• The ‘nuclear’ option of reducing benefits – though this would require the approval of Parliament. Reducing payments to pensioners to 90%, broadly in line with the compensation paid to non-pensioners, would reduce the PPF’s deficit by around £2bn whilst also reducing the number of schemes which entered the PPF.

LCP’s analysis finds that even in the more serious scenario of a £20bn hit, a combination of adjustments to the PPF’s funding strategy and self-sufficiency targets could be enough to cover the deterioration in funding without the need to cut benefits.

Commenting on the analysis, LCP partner Jonathan Wolff said:

“The PPF has provided valuable peace of mind for DB pension scheme members for more than fifteen years, and it is reassuring to see that this ‘lifeboat’ is relatively well placed to navigate the current choppy waters. The PPF has a range of levers it can pull to absorb increased cost pressures without having to resort to cutting benefits to members. But we cannot be complacent. Recent history has been a reminder that the crucial question is whether the insolvencies which we are likely to see in the coming years will hit firms which also have large DB deficits. There remains a risk that too many such insolvencies could put a serious strain on the system”.