UK - The Pension Protection Fund (PPF) has confirmed the investment strategy of pension funds will be a factor in the new formula for the risk-based part of the PPF levy, ahead of the release of the detailed proposals later this month.

Speaking at the annual conference of the National Association of Pension Funds (NAPF), Martin Clarke, PPF director of financial risk, said the proposals for the new levy formula had been developed over the past year to make it fairer and more stable.

At present, the PPF levy comprises 20% of a scheme levy based on pension liabilities, and the remaining 80% is the risk-based levy which measures the likelihood of the scheme failing.

"The challenge we gave ourselves was whether it is appropriate to base the risk-based levy on one year of risk," said Clarke.

The new formula, developed in conjunction with other bodies and external advisers including Oliver Wyman, is designed to "make the levy fairer and help provide the stability in individual bills that levy payers are calling for".

Clarke stressed the new formula would require no new information from schemes and potentially has the opportunity to recognise the impact of some of the more sophisticated risk reduction schemes available in the market.

He suggested the new formula would also provide much needed stability for funds, especially in such volatile markets as the aggregate deficit of the PPF 7800 index had risen from around £80bn (€100bn) at the end of September to £125bn by 8 October. 

"We are dealing with some very big numbers, which produce uncertainty; uncertainty equals risk, risk equals cost and cost equals the levy," he added.

However, he pointed out investment risk at the moment accounts for around 50% of the aggregate risk exposure of the PPF, yet it is a risk "we do not discriminate against in pricing the levy".

The new formula will therefore introduce what is essentially a second component to the risk-based part of the levy, which "reflects scheme investment risk" in an attempt to maintain simplicity.

For example, Clarke suggested a scheme with unmatched liabilities and a highly volatile investment strategy would suffer a more adverse impact from market turbulence, so "that would be reflected in the price we charge".

The consultation period for the proposals will be three months, and Clarke revealed the PPF is particularly interested in the possible impact the changes would have, and whether the additional complexity of the changes would "outweigh the fairness".

That said, the PPF said one impact could be that pension funds with a strong scheme sponsor and/or a more volatile investment strategy would have a greater share of the levy, "while conversely weaker schemes and those with stable investment strategies would bear less".

Clarke pointed out the changes would not come into effect until the 2011/12 levy year, and said the PPF would still recognise contingent assets, while the proposals could potentially recognise the risk reducing effects of measures such as buy-ins within the investment formula.

The changes were welcomed by Mark Young, from T-Mobile pension scheme, as he revealed the existing levy formula discriminates against immature schemes through the actuarial side of the calculations.

He said: "We are an immature scheme, only seven years old, with around 10,000 members, less than 300 pensioners and assets of about £300m. Last week, I received a levy notice that requested us to pay just under £4m in the next three weeks. This is equivalent to 1.5% of the scheme's assets. And why? It is proof of the way the actuarial valuation works against young schemes."

Young added although T-Mobile was committed to final salary schemes, the huge PPF bill had caught the attention of the company's board and he warned unless the PPF makes it fairer the future could look uncertain, adding "the problem is the calculation and more work needs to be done on the actuarial side".

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