Techzone

Compensation schemes: who is protected against what

For members of occupational pensions, mainly defined benefit schemes, there are compensation schemes in place with the sole purpose of protecting their pension rights - should either the sponsoring employer become insolvent or the pension scheme suffer a loss as a result of dishonesty.

The three compensation schemes are:

• Pension Protection Fund (PPF)
• Financial Assistance Scheme (FAS)
• Fraud Compensation Scheme (FCF)

Pension Protection Fund (PPF)

The PPF is a statutory fund which pays out compensation to members of eligible defined benefit schemes where the sponsoring employer becomes insolvent on or after 6 April 2005 and the scheme is underfunded.

PPF eligibility

Most occupational defined benefit schemes (and hybrid schemes that have a defined benefit element) are covered by the PPF. However, the scheme must meet certain conditions before it can be accepted into the PPF.

Process for scheme entering the PPF

The normal process is as follows:

1. Section 120 Notice
When an insolvency event occurs at a company which has an associated occupational pension scheme, the insolvency practitioner has to inform the PPF using a section 120 Notice.

The PPF will contact the scheme's trustees to get the information needed to determine if the scheme is eligible to be taken on. Once that information has been received, the PPF has 28 days to make a decision.

2. Assessment period
If the scheme is accepted, it will enter an assessment period, the start date of which will be the date of the insolvency event. This is likely to last a minimum of one year and could be longer, depending on the complexity of the financial situation of both the employer and the scheme, and the possibility of a scheme rescue. The PPF aim to complete assessment periods for most schemes within two years.

During this period the trustees will work out exactly what assets the scheme has and make sure that the scheme members' details are accurate. The PPF will recover what they can from the insolvent employer by acting as a creditor on behalf of the pension scheme.

The scheme will continue to be administered by its trustees during the assessment period, subject to various restrictions and controls.

The final stage of the assessment period is to get an actuarial valuation to determine the scheme's funding position - this is known as a section 143 valuation. This will confirm whether the scheme　can pay member benefits at or above PPF levels. If it can't, the scheme will transfer to the PPF.

3. Transition
This stage involves: 

• reviewing and terminating any contracts that are in place as part of the scheme - for example, with lawyers or advisors; and
• reviewing and transferring the scheme's assets and member data.

This stage usually takes about six months from the when the PPF requested a section 143 valuation.

4. PPF take over responsibility for the scheme
When all the above steps have taken place and the scheme has shown that it has insufficient assets, the PPF will take over responsibility for the scheme.

All members will be given contact details for the PPF.

Insolvency events

For PPF purposes, an insolvency event has happened if either:

1. the appointed administrator or liquidator calls a meeting of the company and its creditors to consider the proposal that:

• the directors of the company file (or in Scotland, lodge) with the court, documents and statements which begin a moratorium where the directors propose a voluntary arrangement
• an administrative receiver is appointed in relation to the company
• the company enters administration
• a resolution is passed for a voluntary winding up of the company without a declaration of solvency
• a creditors' meeting is held which converts a members' voluntary liquidation into a creditors' voluntary liquidation, or
• a winding up order is made or an administration is converted to winding up by court order

or,

2.    the insolvency nominee (who's not the liquidator or administrator) submits a report to the court stating his opinion that meetings of the company and its creditors should be summoned to consider the proposal to pay off creditors a proportion of the debts that are owed to them.

PPF compensation levels

For those who had already reached their scheme's normal retirement age or, regardless of their age, were either already in receipt of a survivor's pension or a pension on the grounds of ill-health, the PPF will generally provide compensation of 100% of the pension in payment immediately before the assessment date. There's no cap on this.

For those under their scheme's normal retirement age:

• PPF will pay compensation of 90% of the pension an individual had built up immediately before the assessment date, revalued in line with the increase in CPI between the assessment date and the start of compensation payments (subject to a cap of 5% for service from 6 April 1997 to 5 April 2009, and 2.5% after). RPI was used before 31 March 2011.
• Historically, there was an overall cap on this compensation, which depended on the individual's age when compensation came into payment. The lower the normal retirement age, the lower the cap. The standard cap was increased for those with over 20 years’ service.
  
  However, the cap no longer applies as, in July 2021, the DWP lost its appeal against a High Court judgment that the cap was unlawful on the grounds of age discrimination.  
  
  The pensions of those affected by the cap will be increased, once calculated. They will also be entitled to arrears of uncapped compensation payments.
• Following the Court of Justice of the European Union's ruling in the case 'PPF v Hampshire' in September 2018, there's also a minimum level of compensation. Scheme members must receive PPF compensation equal to at least 50% of the value of their accrued pension entitlement.
  
  Of course, with the removal of the cap, it would now be very unlikely for this minimum to have to be applied as a result of other factors (e.g. due to differences in the level of increases between the original scheme and the PPF). 

Compensation payments can sometimes be made for survivors on the death of a qualifying individual.

Taxation: PPF payments are subject to income tax. As with occupational pension schemes, tax is deducted before the payments are made.

Compensation payments increases: Once compensation comes into payment, the amount in respect of pensionable service on or after 6 April 1997 will be increased each year in line with CPI (RPI was used before 1 January 2012), up to a maximum of 2.5%. This could be lower than the increases under the pension scheme's rules.

Making PPF compensation before normal retirement age

For those already receiving pension benefits before their pension scheme was transferred to the PPF, payments can continue. But, the compensation payments may be at a reduced level.

Individuals who weren't already receiving benefits when the scheme transferred to the PPF can ask for their compensation payments to start before the normal retirement age. But, the following points should be noted:

• The individual must be at least age 55
• Compensation payments are reduced using early retirement factors as they're being paid for longer
• There are no special terms for those in ill-health

Member options during the PPF assessment period

During the assessment period, certain options are restricted. The trustees remain responsible for paying any pensions from the scheme, but they should be limited to the level of PPF compensation.

A transfer out can only be considered during an assessment period if, before the assessment date, the member had:

• actually asked for a transfer value
• accepted it in writing and
• had designated a receiving scheme

Even if this has happened, the transfer can only go ahead if the trustees:

• are happy that paying it doesn't conflict with the requirement to ensure protected liabilities of the scheme don't exceed the assets (or if it does, the excess is minimal) and
• the transfer payment is reduced so it doesn't exceed the cost of securing the benefits at the level of the PPF compensation

If the PPF does assume responsibility for the scheme at the end of the assessment period, a member won't be entitled to a transfer payment unless their pensionable service ended by the start of the assessment period and, at that time, the member had less than three months' pensionable service in the scheme.

Options available from the PPF on divorce

The options available are: pension sharing, earmarking and offsetting.

However, under pension sharing, a transfer from the PPF to a scheme of the ex-spouse's choice is not allowed - they have to become a shadow member under the PPF. A cash equivalent transfer value would be worked out by the PPF to base the sharing or earmarking order on.

The shadow member's benefits:

• will be revalued from the date the sharing order takes effect until pension age by CPI up to 2.5% annually
• once in payment, any part of the credit from post 6 April 1997 service would increase by CPI up to 2.5% annually and
• the pension age will normally mirror the original member's NRD in the scheme. A shadow member may be eligible for early retirement from age 55

How the PPF is financed

The PPF receives funding through four sources of income:

• taking over the funds and assets of schemes that are transferred to it
• growth on its own investments
• money and assets recovered from insolvent employers of schemes that it takes responsibility for and
• an annual Pension Protection Levy on PPF eligible schemes. There are two parts to the levy:
  
  
  • a scheme based levy and
  • and a risk based levy

More information on the Pension Protection Levy is available on the PPF website.

Financial Assistance Scheme (FAS)

The FAS provides compensation to eligible members of qualifying defined benefit schemes that can't pay the full amount of accrued benefits.

It's managed by the Board of the Pension Protection Fund.

FAS eligibility

Qualifying Schemes: For a scheme to qualify for compensation under the FAS, the principal employer must be insolvent and the scheme must:

• be a defined benefit scheme and 
• have started to wind up:
  
  
  • between 1 January 1997 and 5 April 2005, or
  • after 5 April 2005 but the scheme is ineligible for help from the Pension Protection Fund due to the employer becoming insolvent before this date), or
  • after 23 December 2008 but before 28 March 2014, if the scheme's connection with a statutory employer was lost before 10 June 2011 and that statutory employer became insolvent before 6 April 2005 and
• have notified the FAS by providing the required information

The FAS closed to new applications on 1 September 2016. Members currently receiving FAS payments (or members with a deferred entitlement) are not affected by this. 

There's a list of qualifying schemes on the Pension Protection Fund website.

Eligible members: To qualify for compensation, an individual would have had to have been a member of a qualifying scheme immediately before it started to wind up.

This includes members who have transferred their pension benefits or commuted them under triviality rules after the scheme started to wind up. A notional rate of pension in respect of the transferred or commuted benefits is used to calculate the FAS payments. This is done by using actuarial factors that give a reasonable estimate of the amount of pension that could have been bought by the transferred or commuted amount.

The surviving wife, husband or civil partner of a deceased member may also be eligible for help from the Financial Assistance scheme if:

• the member died after the scheme started to wind up, or
• the member died before the scheme started to wind up and the survivor was entitled to pension payments immediately before the scheme started to wind up

A survivor's eligibility is unaffected if they remarry or form a new civil partnership.

FAS compensation levels

The FAS will pay compensation to eligible members of qualifying schemes of up to 90% of the accrued pension the member had before the scheme started to wind up. The compensation is paid as a top-up to any pension the member receives from the qualifying scheme, with the combined total subject to a cap - this was not affected by the ruling on the PPF cap. The cap depends on the date that entitlement starts:

However, as those with long service could be harder hit by the cap than colleagues with short service, the cap is increased by 3% for every full year of pensionable service above 20 years. However, there's still a maximum, which is double the standard cap.

Following a Court of Justice of the European Union ruling in September 2018, there's also a minimum level of FAS compensation - regardless of the cap. Scheme members must receive FAS compensation equal to at least 50% of the value of their accrued pension entitlement.  

The following simplified example helps explain the principle of FAS top-up payments.

If tax free cash has already been paid, the FAS will convert the amount into a 'notional annuity'. This gets added to the pension actually being paid by the scheme to give a total rate of scheme pension. The FAS then tops this up to 90% of the expected pension.

Revaluation of accrued pension up to payment date: When calculating the FAS compensation, the accrued pension amount is revalued from the date the scheme started to wind up until the time the payments are due to begin. The level of revaluation is RPI (up to 5%) for the period up to 30 March 2011 and CPI (up to 5%) from 31 March 2011.

Increases in payment: FAS payments are paid for life. Any compensation in payment in respect of scheme service from 6 April 1997 will be increased each year in line with CPI (up to 2.5%).

Ill-health: Payments will be actuarially reduced if they start early as a result of ill-health, unless:

• they have a progressive disease and a life expectancy of six months or less, or
• they're in ill-health and age 55 or over and have a progressive disease from which death might be reasonably expected within the next five years

Taxation: FAS payments are subject to income tax. As with occupational pension schemes, tax is deducted before the payments are made.

Membership of multiple qualifying schemes: If someone was an eligible member of more than one qualifying scheme, they could be entitled to FAS compensation payments in respect of each scheme, meaning that they could receive compensation in excess of the cap. Similarly, someone could be entitled to compensation in their own right and as a survivor.

Making FAS compensation before normal retirement age

FAS payments for eligible members of qualifying schemes normally start from the original scheme's normal retirement age, subject to a lower age limit of 60 and an upper limit of 65.

Payments to surviving wives, husbands or civil partners can start at any age.

Payments are made in arrears on 21st of each month. If the FAS is late in starting the payments, the first payment will include any arrears that are due.

Ill-health: The age at which FAS payments can start for those in poor health depends on the severity of the illness.

• Members who are terminally ill (i.e. those who have a progressive illness and a life expectancy of six months or less) could have their FAS payments start at any time
• Members in severe ill-health (i.e. those who have a progressive illness from which death might be reasonably expected within the next five years) can receive FAS payments from age 55
• Members in ill-health (i.e. those who are unlikely to work again before the normal retirement age of the scheme) could receive FAS payments up to five years before the scheme's normal retirement age

Fraud Compensation Scheme (FCF)

The FCF is a statutory fund run by the Board of the PPF to provide compensation for occupational pension schemes which have experienced a loss because of an offence involving dishonesty and where the sponsoring employer has gone bust.

A High Court ruling on 6 November 2020 clarified that the FCF may also provide compensation to individuals who were incentivised to transfer their pension into a scam occupational pension scheme - sometimes referred to as a 'pension liberation scheme'. Such schemes typically made the funds either wholly or partly available to the member as a cash sum, sometimes as a loan arrangement.

The scheme is funded by the Fraud Compensation Levy, paid by eligible schemes.

Which schemes are eligible?

Most occupational pension schemes (both defined benefit and defined contribution) are eligible, but there are some notable exceptions, such as:

• one member schemes
• death in services only schemes
• various classes of public sector and related schemes (e.g. unfunded schemes, guaranteed schemes, Local Government scheme)
• most SSAS
• non-registered pension schemes

With regard to individuals who have lost out as a result of scam schemes, the FCF only relates to occupational pension schemes, so there's no scope to compensate individuals who transferred to other types of schemes - particularly personal pension schemes - and then lost out.

FCF compensation - when it's paid and how it's calculated

Firstly, the pension scheme in question must be eligible for compensation.

Secondly, the employer must have suffered a qualifying insolvency event and there's no probability of the pension scheme being rescued. If the employer can't have an insolvency event, then it must be clear that they're unlikely to be able to continue as a going concern.

Finally, the Board of the PPF must be satisfied that the value of a scheme's assets has been reduced because of dishonest action, and that a legitimate attempt has been made to recover the loss from other sources.

If the Board of the PPF accepts the application to provide compensation, the amount will generally be calculated as:

• either the value of the scheme's assets in audited accounts, the PPF valuation, or the last value reported by an accountant, prior to loss (adjusted for any change between the date before the loss and the application date)
  
  less
  
  
• the value immediately before the application date, as reported by an accountant

Before the compensation is actually paid, written confirmation of the amount and the terms will be sent to the scheme trustees. This will also confirm that compensation will be adjusted (even after payment) if any lost monies are recovered from other sources.

Claim process - who and how

A claim can be made by:

• trustees
• scheme managers
• members and other beneficiaries
• scheme administrators, or their representatives

Claims should be made using the Fraud Compensation Fund Application Form, normally within 12 months of either:

• the date of the employer's insolvency event, or
• where there's no insolvency event, the date the trustees, managers, scheme actuary or accountant knew (or should have known) that the employer wasn't able to continue as a going concern

Claims may be accepted outwith this timescale, but only where there's good reason for the delay.

If the claim is successful, the compensation can only be paid directly to scheme trustees, regardless of who made the claim. Where no trustees are in place, it may be necessary for the Pensions Regulator to appoint a trustee.