Large companies hit hardest as PPF proposes Experian scoring changes for third triennium

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1 Page 1 of 5 News Alert 2017/06 30 March 2017 Large companies hit hardest as PPF proposes Experian scoring changes for third triennium At a glance The PPF has focussed primarily on Experian scoring changes in its consultation on the levy rules for the third triennium (2018/19 to 2020/21) with larger companies expected to see their levies increase most. Amendments are also mooted to the certification of Deficit-Reduction Contributions and parent company guarantees, and there could be a levy discount for schemes that can demonstrate good governance. In this News Alert we look at the detailed proposals and the particular areas that are up for consultation. The Detail The PPF s consultation on the third levy triennium (covering the levy years 2018/19 to 2020/21) arrived on 23 March. The areas covered were largely as expected, with the central theme being a concentration on improving the accuracy of the PPF s measure of insolvency risk. The proposals are likely to impact the levies paid by some pension schemes significantly, in particular those sponsored by large companies could see material increases. We encourage any schemes concerned to respond to the consultation before the consultation deadline of 15 May. PPF levies will increase substantially for some schemes reply to the consultation by 15 May if this applies to you Experian scoring changes The biggest changes proposed for the next three-year period are in relation to Experian scores. The main losers are those companies that will be assessed on the new scorecard for large subsidiaries and non-subsidiaries with turnover of 30m or more. The PPF s analysis suggests they could face an average levy increase of nearly 50%. Non-subsidiaries with over 30 million turnover and large subsidiaries are expected to see an average levy increase of nearly 50% The PPF s headline proposals include: Using a company s public credit rating (if it has one) instead of the insolvency risk calculated by Experian s PPF insolvency risk model the PPF s analysis confirms that the ratings given by specialist credit rating agencies are more predicative of insolvency risk than the Experian model. The proposals include a mapping of credit ratings to PPF levy bands; as examples, companies

2 Page 2 of 5 rated A- would be in levy band 1, those rated BB+ would be in levy band 5 and those rated B- would be in levy band 9. Using industry specific scores for certain financial institutions instead of the standard Experian scores the insolvency risk scores for certain banks, insurers, reinsurers and mortgage providers could be calculated on an industry-specific scorecard (if they do not have a relevant public credit rating, above). Re-writing five of Experian s current scorecards only the three group scorecards would be retained from the current position - see the graphic below for details. Dispensing with the monthly averaging of Experian scores there are proposals to use just the insolvency score as at 31 March or average over a shorter period rather than the 12-month average of scores used in the current calculation. For 2018/19, given the formulae will not be finalised until the autumn, there will be at most six months of averaging from the end of October 2017 to the end of March A free pass into the best levy band for certain Government/Crown backed entities - the PPF is proposing to give itself the power to place entities established by statute or wholly or directly owned by the Crown, central government or a statutory authority in levy band 1. It feels the current Experian model does not fully reflect the security of these employers. As noted above, five of the eight Experian scorecards are being rebuilt and in some cases rebranded, as the following PPF graphic illustrates: Company credit ratings and specific financial industry scores could be used to assess insolvency risk Five of the eight current Experian scorecards are being re-written Where scorecards are being rebuilt they will no longer include the age of most recent mortgage variable. This has been a source of misery for many schemes, particularly those run by mutual societies and similar organisations.

3 Page 3 of 5 Helpfully, Experian s PPF insolvency score portal has already been updated allowing schemes to check the effect of the proposed changes on sponsoring employers Experian scores. Note that the PPF expects insolvency scores to generally deteriorate under the revised scorecards. However this doesn t necessarily mean an increase in the PPF levy for individual schemes as it seems likely there will be an associated decrease in the levy scaling factor in order for the PPF s sums to add up. The Experian portal has already been updated for the new scorecards check your scores now The proposed adjustments to CRA rated entities and those in the financial sector are not yet reflected on the Experian portal. The maths might say that the new scorecards will more accurately represent companies insolvency risk, but an expected 50% increase in levy for larger companies will be difficult to stomach. These entities are generally those with the biggest pension schemes and already paying substantial levies, and the increase is in effect paying for a general reduction in levy for all other groups of sponsors. Deficit-reduction contributions to be simplified? The certification of deficit-reduction contributions could get much simpler under the PPF s proposals. There are two separate suggestions: removing the allowance for investment expenses (one of the more complicated elements) from the calculation; or a change to the much simpler approach of certifying the contributions paid under a scheme s recovery plan. We welcome the simplicity of the PPF s proposals. Although the current approach may be technically more accurate, we question whether the effort and expense of going through the process is adding much in the grand scheme of things. Deficit-reduction contributions could become easier to certify The contingent asset regime continues evolving The PPF has also proposed several changes to the parental guarantee regime, including: Trustees certifying a parental guarantee for 100 million or more would be required to take professional advice. In particular they would need to obtain a guarantor strength report to evidence the amount certified. Currently guarantors who are also employers within the scheme have to certify their own portion of the scheme s underfunding risk as well as the amounts attributable to the other employers. The PPF is exploring ways in which the levy formula can be adjusted to better reflect that the guarantor only needs to guarantee Schemes would be required to take professional advice when certifying a guarantee for 100 million or more

4 Page 4 of 5 the liabilities of the other employers (whilst continuing to meet its ongoing commitments). Schemes with multiple guarantors may be able to certify the guarantee at different levels for each guarantor. The PPF s standard form agreements, the documents that set out how contingent assets should be structured to be PPF-compliant, are undergoing a thorough review. The PPF is proposing that existing guarantee documents should be reexecuted in line with the new format. Possibly treating Asset-Backed Contribution ( ABC ) arrangements based on unsecured loan notes in a similar way to parental guarantees in terms of the associated levy savings. The PPF continues to expend considerable resource policing the contingent asset framework for levy reduction, with mixed results. The requirement for professional advice where levy savings are potentially large is aimed squarely at reducing that workload, for which we have some sympathy. What is less clear to us is the need to revisit every contingent asset agreement in existence, with the associated advice costs and upheaval that would entail. Levy reductions for good scheme governance? The Work and Pensions Select Committee recommended to the PPF that it consider how the levy framework could incentivise good scheme governance. The PPF has addressed this in the consultation by asking levy payers a fundamental question how could good governance be measured and applied to the levy? And there could be a discount for good scheme governance The PPF are keen not to make it a tick-box approach, with schemes simply producing the documents/processes required to get a levy discount without truly putting them into practice. On the other hand the approach clearly needs to be measurable and capable of simple application to the levy formula. Whilst a nice idea in theory the PPF is clearly struggling to find a practical way to implement the thought. There may well be an element of double-counting in all of this if good governance is anyway reflected in a well-funded appropriately invested scheme paying modest levies. Help for smaller schemes The PPF recognises the difficulty many small schemes have engaging with a complex series of rules given the associated professional advice costs, and is asking for suggestions on improvements or simplifications that may help smaller schemes.

5 Page 5 of 5 Actions The following actions will help you check whether a response to the PPF consultation might be beneficial for your scheme: sponsoring employers with a credit rating should check the impact of basing their insolvency score on that credit rating; other companies, especially the largest companies, should check how the new proposed Experian scorecards will affect them by logging into the Experian PPF score portal (companies on the new financial institution scorecard should note that is likely to take precedence over their Experian score); schemes that certify parental guarantees above 100m should assess the impact of professional advice costs on their levy savings, and all schemes with PPFcompliant guarantees consider the implications of re-executing them; and smaller schemes and schemes with good governance may wish to consider ways in which the levy could more easily recognise their particular features. The PPF intends to publish a consultation response later in the year, together with the draft rules for 2018/19 levy calculations. Check now how the proposals could affect your pension scheme Please contact your usual LCP representative if you would like to discuss the PPF s proposals further or if you believe they could significantly affect your scheme. This News Alert does not constitute advice, nor should it be taken as an authoritative statement of the law. If you would like any assistance or further information on the contents of this News Alert, please contact David Everett or the partner who normally advises you at LCP on +44 (0) or by enquiries@lcp.uk.com. w LCP is a firm of financial, actuarial and business consultants, specialising in the areas of pensions, investment, insurance and business analytics. Lane Clark & Peacock LLP Lane Clark & Peacock LLP Lane Clark & Peacock Lane Clark & Peacock London, UK Winchester, UK Ireland Limited Netherlands B.V. Tel: +44 (0) Tel: +44 (0) Dublin, Ireland Utrecht, Netherlands enquiries@lcp.uk.com enquiries@lcp.uk.com Tel: +353 (0) Tel: +31 (0) enquiries@lcpireland.com info@lcpnl.com All rights to this document are reserved to Lane Clark & Peacock LLP ( LCP ). This document may be reproduced in whole or in part, provided prominent acknowledgement of the source is given. Lane Clark & Peacock LLP is a limited liability partnership registered in England and Wales with registered number OC LCP is a registered trademark in the UK (Regd. TM No ) and in the EU (Regd. TM No ). All partners are members of Lane Clark & Peacock LLP. A list of members names is available for inspection at 95 Wigmore Street, London, W1U 1DQ, the firm s principal place of business and registered office. The firm is regulated by the Institute and Faculty of Actuaries in respect of a range of investment business activities. The firm is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are licensed by the Institute and Faculty of Actuaries. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. Lane Clark & Peacock LLP.