Thousands of UK companies will put more effort into improving their credit rating to reduce their Pension Protection Fund levies, than they will into dealing with pension scheme deficits, suggests research from Aon Consulting.
Research suggests companies are focusing on reducing their PPF levies as it can be done quickly and at whereas while dealing with a pension deficit is a much heavier financial burden, and in some cases has little or no effect on the levy a pension scheme can expect to pay.
For example, if a company’s credit rating is 'risk band two', with a pension deficit of £140m, the estimated total levy for 2006/7 will be £850,000, according to the study, however, if it reduces its deficit by £20m to £120m, but stays in the same risk band, its levy will be reduced just 12% to £748,000.
However, if the pension fund keeps its £20m, the deficit stays the same at £140m, but improves its credit rating into risk band one, then the levy would be reduced by 75% to just £212,000, according to Aon's analysis of the PPF.
Paul McGlone, principal and actuary at Aon Consulting, says given the huge differential between each risk band, the most effective way companies can reduce their PPF levy is to look for ways to improve their risk banding, rather than paying cash into their schemes to reduce deficits.
He adds although it seems logical for companies to pay cash sums into their scheme to reduce the levy, this could potentially make it worse by putting the company in a higher risk band because of a reduction in the company’s liquidity.
Aon also argues while the current focus on credit ratings is a sound strategy for businesses, the new rules are a major cause for concern because they encourage those managing a pension scheme to focus on reducing short-term costs, rather than meeting the long-term challenge of reducing the pension deficit.
McGlone suggests a contributing factor to this behaviour is the small number of risk bands proposed by the PPF Board and the large differentials between them, which means companies have significant amount sto gain or lose by relatively small changes to their credit rating.
“We would favour a move to a larger number of risk bands, with amore gradual change in PPF levies. This would be fairer across the board and mean that companies could focus more time on the real problem of dealing with the pension scheme deficit," says McGlone.
John Lavabre, spokesman for the Pension Protection Fund, says: “We are producing an update on our risk-based levy work which will be released on December 16.”
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