Pension Protection Fund and Occupational Pension Schemes (Levy Ceiling) (No. 2) Order 2023

Wednesday 26th April 2023 Grand Committee

Motion to Take Note

18:31

Moved by

[Lord Davies of Brixton]

That the Grand Committee takes note of the Pension Protection Fund and Occupational Pension Schemes (Levy Ceiling) (No. 2) Order 2023, given the impact of current increases in the cost of living on pensions payable by the Pension Protection Fund.

Relevant document: 30th Report from the Secondary Legislation Scrutiny Committee

[Lord Davies of Brixton (Lab)]

My Lords, this order is routine and has little practical impact on the PPF. The levy that is currently payable is only 16% of the cap set by the order. However, having it before us provides an opportunity to discuss the operation of what is becoming—a bit under the radar—one of the country’s biggest financial institutions.

I have a particular interest as I like to think that the PPF, or at least the name, was my idea. Back in 1995, following the Maxwell scandal, I drafted a paper for the TUC that proposed, among other things, that there should be a central discontinuance fund that should be called—wait for it—the Pensions Protection Fund, or PPF. Of course, the proposal was not accepted at that time, but it was introduced subsequently in the Pensions Act 2004.

Before getting to the focus of my speech, I have a couple of questions. First, the Minister should provide the Committee with some explanation of the error that was made with this order. I am not trying to embarrass anyone, but it surely suggests excessive pressure on DWP staff, so the question is: has the situation been rectified?

Secondly, as was raised in the 30th report from the Secondary Legislation Scrutiny Committee, can the Minister tell us where we have got to in following the recommendations in the departmental review? I will highlight two recommendations from the review. First, recommendation 2 is that

“the DWP and the PPF work together to understand the implications of the PPF’s funding position in light of expected future developments in the population of Defined Benefit (DB) pension schemes and plan well ahead for any legislative changes that might be needed; for example, to address what happens to any funding which is surplus to requirements”.

It is worth noting that the current legislation says nothing about what should happen to any assets that, in the event, are not needed to pay members’ benefits. Given the PPF’s policy of building up a substantial buffer that, even on its own figures, is unlikely to be needed, the question needs to be addressed.

Any money that is left over cannot go back to the employers, because things will have moved on and employers will have moved on. It also seems wrong that it should go to the Government. The only just solution is for it to be used, as far as possible, to provide benefits for members. In practice, this means that the buffer should not be excessive. In these circumstances, where there is no residual legatee, bigger is not necessarily better. It might be unjust, and its level therefore becomes not just a technical issue but an issue of fairness to members.

Recommendation 6 states:

“The PPF should consider how the Board could hear more directly about the member perspective to inform its deliberations”.


It should be a matter of concern that currently there is no formal procedure to reflect the interests of members. So what thought are the Government giving specifically to these two recommendations in the context of the review?

These two recommendations also bring me to focus on the central issue of my remarks: the impact of high rates of inflation on pensions in payment from the PPF and the scope for the fund’s assets to be used to protect their real value. The problem is that the limits on annual pension increases are severe in current circumstances: none at all for benefits accrued before 1997 and only 2.5% per annum for benefits accrued thereafter. Until recently, the PPF operated in a period of relatively low inflation. The problem of inflation has always been there, but it has become more salient now we have moved into a period of materially higher rates of inflation—most obviously in the current year, but the issue is not going to go away.

The net effect of these limits is that the real value of members’ pensions has been cut significantly. Pre-1997 benefits have already been cut by up to one-third, while benefits accrued after that date have fallen by up to one-sixth. It is important to understand that these are reductions so far; they are going to continue. There is bound to be another cut next January, which will be based on the level of inflation this coming May. It is potentially another 7% if we believe the OBR’s forecasts. In the longer term, I am a relative pessimist about inflation —but even optimists do not expect a return to CPI increases of 0% or even 2.5%. So the need to protect the real value of members’ benefits will only increase.

The reductions in the real value of members’ benefits must be seen in context: the funding position of the PPF, in its own words, is “strong”. As a result, the PPF levy has, quite rightly, been reduced and there are plans to reduce it further. I have no problem with that. According to the PPF’s latest annual report and accounts, the scheme held £39 billion in assets as at 31 March 2022. At that point, the PPF estimated that, of that figure, £11.7 billion—almost £12 billion—was in excess of what it needed to pay every current member and their dependants their compensation for life. This represented a funding ratio of 137.9%. I think that would be broadly recognised as going a bit beyond “strong”.

Given the experience of the last 12 months, it is likely that the position this March will be materially stronger. It also needs to be understood that these figures are already being calculated—I presume—on a prudent basis. The general practice is to undertake these valuations on a prudent basis. Unless the PPF advises me otherwise, I assume that this is the case here, so we have prudence placed on top of prudence.

The problem with all this is that PPF members have not shared the benefits of this strong funding position. Indeed, it is the reduction in the real value of their benefits that has been one of the contributing factors to the strong position. This situation is wrong and should be remedied as soon as possible. This will probably require legislation because the board of the PPF has limited ability to pay compensation over the levels set in the Pensions Act. The lack of increases for compensation in respect of pre-1997 service is devastating for the members who are affected, especially during the current cost of living crisis.

As well as the size of the impact, it is also important to appreciate the differential effect on various groups of members. Information released to the trade union Prospect through a freedom of information request shows that the lack of inflation protection for pre-1997 service disproportionately impacts women and older members. There is no rational justification for this discriminatory treatment. Ministers have sought to justify the discrimination by saying that there was no statutory right to increases before 1997—true, but there was no statutory right to have an occupational pension at all. The idea that the initial pension is the real benefit and the increases are an optional extra is fundamentally wrong.

In practice, the majority of pre-1997 scheme members were either accruing benefits to which they were entitled through RPI increases, typically capped at 5%, or were in the many schemes funded on the basis that such increases were going to be provided and members had a reasonable expectation of receiving them. In other words, such increases were part and parcel of the package of scheme benefits, and their effective exclusion from protection must be open to legal challenge. Such a challenge becomes more likely as higher rates of inflation persist. So we should, first, provide higher rates of protection to better reflect modern rates of inflation and, secondly, eliminate the arbitrary and unfair difference in treatment for compensation in respect of pre-1997 and post-1997 service.

On a Brexit note, it is a matter of much regret that the Retained EU Law (Revocation and Reform) Bill does not provide for the retention of the minimum levels of compensation established in the Hampshire and Bauer cases. When that Bill was debated in the Commons, a Minister even went so far as to state that the Hampshire case

“is a clear example of where an EU judgment conflicts with the United Kingdom Government’s policies”.—[Official Report, Commons, Retained EU Law (Revocation and Reform) Bill Committee, 22/11/22; col. 169.]

To conclude, is it the Government’s intention to cut the potential benefits that members might receive from the PPF to below the level to which they are entitled at present? I beg to move.

[Baroness Drake (Lab)]

My Lords, the PPF provides real support to some 295,000 pension scheme members who have entered it, including through the £1.1 billion paid out in compensation each year. It provides security to those in current DB schemes who may need to call on it in future. Add to those figures the Financial Assistance Scheme, which covers a further 150,000 members and, following the Pensions Act 2004, is administered by but not funded through the PPF, and we are providing a blanket of considerable security to heading for half a million people.

It is very important to remember that, before the 2004 Act, members could lose all or much of their pension savings when employers became insolvent or simply walked away from their liabilities. When the Labour Government created the PPF, there were many doomsayers who predicted that it would not be sustainable. In fact, the PPF has defied those doubters: it is financially resilient, has been well run, and has weathered the various economic storms that have occurred over the past 15 years.

18:45

However, the financial resilience of the PPF over the very long term still needs careful consideration. I probably take more comfort from the cosiness of prudence than my noble friend does, but the past few years have seen a significant improvement in overall scheme funding through increased employer contributions, rising interest rates and, more recently, rising gilt yields. I acknowledge that, but there is always the risk of the economic environment worsening and future large claims on the PPF. There will be a decline in the number of PPF levy payers resulting from schemes transferring into the PPF, and the number of schemes likely to buy out with an insurance company. Schemes underfunding is one of the biggest risks that the PPF faces, and there are still scenarios in which scheme funding could deteriorate. We have seen rapid movements in the level of scheme funding. What we have witnessed over the past 15 years confirms that.

The funding regime for the remaining open schemes is also important. Many of the larger such DB schemes have considerable deficits on a Section 179 basis—that is, the basis for funding to provide a PPF level of benefits. The Purple Book shows that open schemes are around 20% worse funded than closed schemes, on a Section 179 PPF benefits level basis. Such schemes presenting to the PPF could have a significant impact on the PPF’s funding, if they made a claim. There is also a long tail of small schemes which, together with stress schemes, collectively constitute, as I understand it, over one-third of the remaining 5,100 DB schemes. The estimates suggest that the annual capacity of the buy-out market is £50 billion to £100 billion, but it is likely to be the stronger schemes that buy out, with the less financially resilient schemes left in the PPF universe.

I mention all those things because, although the PPF is resilient when looked at today, we know that the risks that it has to be embrace and deal with can move against it. What work is being done to assess the impact and extent of a future decline in the number of levy players and the implications for the annual levy and the financial resilience of the PPF? In the light of the PPF’s current improved resilience, I understand that the DWP and the PPF are jointly considering the potential for more flexibility in setting the levy. Is the Minister able to report on when we are likely to know the outcome of those deliberations?

Improved PPF financial resilience, against a background of current high inflation levels, is bound to raise questions about current compensation levels paid to scheme members who entered the PPF. Looked at over the long term, an important part of maintaining the financial resilience of the PPF and the fairness towards levy payers has been the level at which PPF compensation payments are set. As my noble friend spelled out, current compensation payments are inflation indexed only on pension benefits accrued since 1997, not on benefits accrued before then, and the index is capped at 2.5%.

Understandably my noble friend is concerned that, in the face of high inflation and its impact on members of the PPF, the annual levy for 2023 is being reduced to 16% of the levy ceiling, given that there are some strong arguments for saying that the level of compensation payments should be improved. Again, I go back to my natural affection for prudence. Changing the PPF compensation levels, specifically to provide improved inflation indexing, would have a material financial impact on the PPF and wider implications for DB schemes, and, by association, the funding of the Financial Assistance Scheme. Changes to indexing would need consideration of the level of increase on the PPF’s future liabilities and the impact on the number and size of claims that the PPF would receive in the future, and it would almost certainly raise arguments about the cost of backdating any index payments.

We would also have to deal with schemes that had wound up outside the PPF through buyout at a level of benefit above current PPF benefits but which, if compensation payments are increased, would have been better off if they had transferred into the PPF. More schemes will become underfunded on a Section 179 basis. In looking at ways in which compensation could be improved, particularly for benefits accrued prior to 1997—I am hesitating on my memory—there are some quite serious issues to reflect on.

I am aware that the Work and Pensions Committee is looking at the system and the level of PPF compensation. Without treading on its toes, I ask the Minister whether there are any plans to increase the transparency of reporting on the department’s consideration of the annual levy raised, and about the scope for increasing the level of compensation to members in a high-inflation environment, and the need to ensure financial resilience of the PPF in the face of other risks evolving over time.

The other issue is that the PPF will be entering its own maturing phase, which will require it to have a greater focus on maintaining financial resilience. Reading the various papers that we had before us, I did wonder whether, in those circumstances, the PPF is right to decide to build reserves at a significantly slower pace than it had been building them. Certainly, in the DB scheme world, the regulator often encourages DB schemes to get assets in while the covenant is strong, and not wait until it is weak and seek the money. I wondered whether it is such a good idea to slow down the building at pace of reserves.

Finally, is it possible to update the Committee on the DWP’s view on the maturing of the PPF, which is a kind of shift in its position? I appreciate that it may not be possible to make a verbal response to that, but a written response would be helpful.

[Baroness Altmann (Con)]

My Lords, I congratulate the noble Lord, Lord Davies, on securing this debate; it is an important one. At the outset, I say that I believe that the Pension Protection Fund has done and is doing an excellent job, and member experience in the PPF seems to be very positive—for me, that is one of the big tests of whether this is working well. The administration is very efficient, and the amount of compensation being paid is reaching those who need it, and are entitled to it, well.

I also congratulate the noble Lord on his foresight in 1995. I recall first becoming involved with Allied Steel and Wire and the various other pension schemes whose members had lost their entire pension very close to the point at which they were expecting to start receiving it, together with all their other life private savings —in those days, if you wanted to have any extra pension contributions you had to put all of it into your employer’s pension scheme. I remember reading about the proposals for a central discontinuance fund and thinking, “If only”. It informed my conversations with the No. 10 Policy Unit, the Treasury and the economic advisers to the Prime Minister at the time as to which way we needed to go to improve the situation the country faced. Over the subsequent two to three years, more and more pension schemes failed, and more and more members started losing their pensions; it was a serious and heartbreaking time. Members, having been told that they were fully protected, would have expected that all their money was safe. They were told that, regardless of what happened to their employer, their money was safe and that their pension was protected—but it turned out not to be the case.

Instead of the proposal from the noble Lord, Lord Davies, of a central discontinuance fund, we got the actuarial profession’s minimum funding requirement. Unbeknown to members—and, indeed, to most pension professionals outside actuarial circles—that was designed to deliver only a 50:50 chance of people receiving their full pensions, and yet members, trustees and employers were told that, on that basis, their fund was fully funded or in surplus. Unfortunately, what happened subsequently, around the end of the 1990s, with the market crash, was that those surpluses melted away. It looked as though the benefits had been secure but, suddenly, the market crash made that position unsafe. We saw that those so-called surpluses were in fact buffers against bad markets, rather than real surpluses—you could judge that only with hindsight in the end.

This is my concern about the Pension Protection Fund. I absolutely want to try to ensure that anyone who has a pension insured by the Pension Protection Fund receives as much as possible. If there were a secure way of ensuring that they did not fall behind while we are suffering this cost of living crisis, I would be the first to support it. My thinking has perhaps been coloured by my experience during those dreadful years, before we got the Financial Assistance Scheme sorted out in 2007—it started around 2008—of seeing people who thought that their pensions were in surplus and that their position was secure finding that, because markets had moved suddenly and unexpectedly and in a way that had never been properly forecast, their pension had disappeared.

I also believe that, although the PPF looks as though it is in surplus now, we need to address what happens should there be a severe economic dislocation causing some of the huge pension schemes, which currently seem safe—and even some of the open schemes —to fail and fall into the same problem. This is an insurance policy rather than a pension, which, for me, is an important distinction.

I would love the Government to find a way to underwrite more generous increases for the Pension Protection Fund. I am particularly mindful of the fact that, before 1997, benefits had no inflation protection at all, yet many schemes—but by no means all—offered full inflation linking, or at least up to 5%. In that pre-1997 period, the older the member was when their scheme failed, the more pension they lost as a result of the failure, because they would have had more accrual.

I support the concept that the noble Lord, Lord Davies, is promoting: that in a time of economic difficulty, with inflation roaring away, we do not want to leave pensioners behind. It is clearly the case that the Pension Protection Fund is, to some degree, leaving pension members behind in real terms. To some degree, it was modelled on the American PBGC, the Pension Benefit Guaranty Corporation. Generally speaking, in America there is no inflation protection at all on these DB schemes, so the UK has always been a little unusual in that regard. Having said that, it makes sense to look at the structure of the levy and I echo the questions for my noble friend about plans for the future management of it.

19:00

Finally, to pick up on the remarks of the noble Lord, Lord Davies, on the arbitrary and unfair treatment of pre-1997 members, that applies particularly strongly to members in the Financial Assistance Scheme. This scheme is not funded by all other pension schemes or employers; it is a part of government spending. Members in the Financial Assistance Scheme were never told that there was a Pension Protection Fund that would reduce their pension when they reached retirement; they were always told that their pension was completely “safe and protected by law”, to cite government documents sent to them at the time. They would be particularly at risk, because their schemes failed before the schemes that belonged to the PPF. They would be at risk of losing more because, by definition, they had more pre-1997 benefits.

May I put in a plea? Given that the Financial Assistance Scheme’s membership is more than half the size of the membership of the PPF, if there were any consideration of increasing the generosity of inflation protection for members of the Pension Protection Fund, even on a one-year basis, for example could that be applied to the Financial Assistance Scheme as well? It would be an option to offer them extra on a temporary period. On that basis, does my noble friend know, or will he write to me about, how much extra money the Government have so far added to the assets that were gathered in from Financial Assistance Scheme schemes to supplement the amounts paid out for members of those schemes?

I congratulate the noble Lord, Lord Davies, on this. I echo the words of the noble Baroness, Lady Drake, who knows so much in this area, about a need to be mindful of the longer-term potential risks. I look forward to hearing my noble friend’s response.

[Baroness Sherlock (Lab)]

My Lords, I thank all noble Lords who have spoken, especially my noble friend Lord Davies of Brixton for giving us this opportunity to reflect on the role and operation of the Pension Protection Fund.

My noble friend Lady Drake was right to remind the Committee of the huge value of the PPF to the thousands of members of DB schemes—both those who benefit directly from the £1 billion-plus of compensation it pays out every year and those who are happily sailing in calm pension waters but benefit from the security of knowing that the lifeboat is there, should they find they need it. Certainly, every day is a school day. I have learned a certain amount of history today, for which I thank noble Lords who have spoken, including the noble Baroness, Lady Altmann, and my noble friends on this side. They reminded me that the PPF was created by the Labour Government to protect the hard-earned pension savings of workers. It is important that we never take it for granted and that we, in our time, do all we can to keep it sustainable.

The Pensions Act 2004 requires the DWP to make an annual order to increase the PPF levy ceiling in line with the growth in earnings. As my noble friend Lord Davies noted, this year we have had two orders, as the first draft omitted the relevant figures in favour of “X”s. I do not want to make life harder for whichever poor person found that they had done that by accident, but I have to note that it is not the first error in recent times that we have had in a DWP order. When I was a non-exec on boards, we were always told that if an error is reported, the question to ask is: is it systemic? Clearly, one error is not systemic, but this is not the first. Can the Minister tell the Committee whether he is confident that his department is sufficiently well resourced with the people whose job it is to draft legislation and make sure that it is checked before it goes out?

The levy ceiling was set in primary legislation to be uprated annually in line with the growth in average weekly earnings, the rationale being that this would allow the increases in the ceiling roughly to track the increases in the pension liabilities of DB schemes, which are, in turn, linked to members’ earnings. In its 30th report, the Secondary Legislation Scrutiny Committee asked whether the policy of annual increase by the growth in earnings is still producing a sensible outcome, or whether it is far outstripping actual usage. It highlighted the gap between the levy ceiling and the actual levy. As we have heard, in 2023-24, the levy will be 16% of the ceiling, compared with 33% in 2022-23 and 43% in 2021-22.

The answer provided to the committee in that 30th report was that

“PPF investment performance has consistently performed ahead of target and combined with the PPF’s levy collection and risk reduction strategies, has resulted in a reserve of £11.7 billion and assets of £39 billion (as of 31 March 2022)”—

as mentioned by my noble friend Lord Davies. It was this which enabled the drop in the levy. The recent PPF funding review concluded that

“the PPF’s financial position has significantly strengthened in recent years, driven principally by strong investment performance, and a changed risk profile. As a result, the PPF is making a step change in its approach and entering a new phase where the focus will shift from building to maintaining its financial resilience”.

As somebody who likes the Janet and John version, I think that means that it has been building up reserves steadily and feels that the time has come to build them up more slowly in future.

The challenge for the PPF is that it has to tack a course between levying enough for its likely needs in the year ahead while ensuring that it is still able to bring in enough additional revenue if it suddenly faces large claims or a significantly riskier environment. Since it can increase the levy by only 25% a year, the decision on the levy can never just be a short-term consideration with a 12-month horizon. Is the Minister confident that the PPF has landed in the sweet spot?

I am also interested to hear the answers to the questions raised by the noble Baroness, Lady Altmann, and my noble friend Lady Drake about the consideration that is being given by the department and the PPF as to whether there is a need for more flexibility in the way that the levy is set and constructed.

Clearly, if the PPF is deemed to have more reserves than it needs, it can do one of two things: reduce the levy or spend more. My noble friend Lord Davies has come down clearly on one side of that, namely that it should choose to spend more. He rightly pointed out that this is a time of very high inflation and, therefore, the impact of the 2.5% cap on indexing is being felt particularly acutely at the moment. Clearly, that has put pressures on all pensioners, including those who rely on PPF payouts. My noble friend’s proposal has attracted support in principle from the committee. The obvious question to the Minister is: has any modelling been done on the cost of removing or raising the cap and, if so, what can he share with us on that—what did it show?

My noble friend Lord Davies also raised two of the questions from the independent review of the PPF. Can the Minister tell me whether the Government have responded to that review? I could not find it, but that may just be because of my search skills. Perhaps he could let us know.

I add another question that had been raised. The costs of administering the PPF are borne by the PPF administration fund and amounted, I gather, to £13.3 million last year. The independent review recommended folding the administration levy into the general PPF levy. Did that proposal find favour?

I am interested to hear the Minister’s take on this delicate balance facing the PPF, especially as it matures. It has been suggested that is in a healthier position than ever, but also that, as more schemes prepare to move into buyouts, the environment could get riskier in future than it has been in the past. It is perhaps time for more of the workings to be made manifest so that there is more clarity for all stakeholders—pension schemes, savers and pensioners—as to the balance of decisions that are being taken. I look forward to hearing the Minister’s reply.

[The Parliamentary Under-Secretary of State, Department for Work and Pensions (Viscount Younger of Leckie) (Con)]

My Lords, I thank the noble Lord, Lord Davies of Brixton, for providing this opportunity to discuss the Pension Protection Fund and Occupational Pension Schemes (Levy Ceiling) (No. 2) Order 2023. This order enables the board of the Pension Protection Fund to raise a pension protection levy that is sufficient to ensure the safe funding of the compensation it provides, while providing reassurance to business that the levy will not be set above a certain amount in any one year.

I thank all noble Lords who have spoken in this short debate. As ever, I am somewhat daunted by the level of expertise, bar none, in this Committee. A good number of questions have been raised and, as ever, I will endeavour to answer them all—mostly at the end of my remarks, just to manage expectations.

I emphasise the Government’s continued commitment to supporting pensioners and protecting their hard-earned retirement savings. Ensuring that those who have worked hard all their lives receive a retirement income that provides them with dignity and financial security is one of our core objectives, and so it should be. We recognise that recent increases in the cost of living have placed particular pressure on pensioners’ household budgets, so we are taking action to target support specifically at pensioners. Around 12 million pensioners in Great Britain will benefit from the 10.1% increase to their state pensions from this month, fulfilling the Government’s manifesto commitment to apply the triple lock. More than 8 million pensioner households across the UK will receive an additional £300 cost of living payment this winter. To aid the most vulnerable, the pension credit standard minimum guarantee has also been increased by 10.1%.

As the Committee will know, combating inflation is one of the Government’s top priorities. Forecasts indicate that inflation is still likely to fall sharply by the end of 2023, in line with the Prime Minister’s pledge to reduce it by half by the end of the year.

I will return to the Pension Protection Fund in a moment, but first I will take a step back to consider the wider context of the schemes it protects. I pay tribute to the noble Lord, Lord Davies, for all that he has done; I was interested, pleased and perhaps not surprised that he had such a hand in the naming and setting up of the PPF—I am not sure of the precise date—back in the 1990s. With around £1.7 trillion of assets over 5,000 schemes and supporting nearly 10 million members as of March 2022, the defined benefit sector is critical for the UK population.

Set against this backdrop, the PPF’s £39 billion in assets under management as of March 2022, including £11.7 billion in reserves, certainly seem proportionate to the scale of its task. As of March 2022, since its inception in 2005 the scheme has stepped in to protect close to 300,000 members who might otherwise have received a greatly reduced retirement income. The noble Baronesses, Lady Drake and Lady Sherlock, referred to the success of this.

Despite the strength of its financial position, the PPF continues to face risks, the biggest being future claims for compensation and increased longevity. It uses its stochastic modelling tool, the “long-term risk model”, to help determine the funding it requires to protect against these future risks. Like other major financial institutions, the PPF protects against risk by holding reserves. The size of its reserve should therefore provide reassurance not only to existing members of the PPF but to members of all eligible pension schemes.

The noble Lord, Lord Davies, asked about the Pension Protection Fund’s reserve of £11.7 billion and asked whether that could be shared with its members—I think that was the gist of his question. It enables the Pension Protection Fund to protect financial security for current and future members. As I said, despite the strength of its financial position, the PPF continues to face a number of risks, the biggest being future claims to compensation and increased longevity, so there is a balance that I am sure the noble Lord could tell me much about.

The compensation provided by the PPF makes it a critical partner in delivering on the Government’s objective of ensuring financial security for pensioners. The PPF provides a crucial safety net to members of eligible pension schemes who are at risk of losing their pensions because of the insolvency of their employer. This safety net could not be more important in these challenging times.

I reiterate, however, that the Pension Protection Fund is therefore a compensation scheme; I know that my noble friend Lady Altmann defined it as an insurance scheme, which is fair enough. As such, it seeks not to replicate the benefits of underfunded pension schemes but rather to ensure that members are compensated fairly and sustainably. A balance must be struck between the interests of those who receive compensation and the levy payers who fund it. It is only by striking this delicate balance, perhaps, that the long-term stability of the PPF can be ensured.

19:15

As it is a safety net, the PPF indexation rules are broadly in line with the minimum legal requirements for defined benefit schemes, which vary depending on the time the benefits were accrued. This means that some members receive lower levels of indexation than they would have done had the scheme not entered the PPF. Changes to these rules would be costly and complex, with significant consequences for the pensions system. The PPF’s current liabilities would increase, as would the deficits of the schemes it protects, which use PPF compensation levels to measure their funding. This would mean an immediate increase in costs as well as an increase in the potential scale and likelihood of future claims for compensation. As a result, the PPF would have to alter its funding strategy, likely increasing the burden on levy payers. It would not be appropriate for the Government to increase the burden on levy payers for the purpose of providing more generous indexation than the minimum as laid out in legislation.

The noble Lord, Lord Davies, expanded on this theme by asking why compensation paid by the PPF does not increase in line with inflation. As he knows, compensation based on benefits accrued after April 1997 is increased in line with inflation up to a maximum of 2.5%, which is broadly in line with the legal requirements for defined benefit pension schemes. However, as I mentioned earlier, it is a compensation scheme and was never intended to replicate the benefits. Legislation limits what the PPF can do and there is no discretion either to pay the uplifting of the pre-1997 funds or to pay more than the 2.5%; I may say more about that later.

As my noble friend Lady Altmann said, the PPF has been highly successful in securing the funding required to pay for the compensation that it currently provides. The strength of its financial position, combined with improvements in the funding levels of the schemes it protects, means that it expects to be able to reduce its reliance on the levy. In 2023-24, it intends to collect approximately £200 million—around half of last year’s levy estimate. Reducing the levy will ease the burden on levy payers without risking the long-term funding of compensation.

I thank the Secondary Legislation Scrutiny Committee for the attention that it has paid to this instrument. I hope that the information provided by the department about the levy ceiling has been helpful for noble Lords’ understanding of this successful compensation scheme. I repeat the department’s apologies for the technical errors contained in the original version of this order. They were spotted by the statutory instrument registrar, and this allowed the department to act swiftly to lay this order—it also revoked the defective order—and minimise any inconvenience. Understandably, this matter was raised by the noble Lord, Lord Davies.

To expand on what I have just said, as the noble Lord knows, the technical error in the original version led to the order having to be revoked. This order, No. 2, now revokes and replaces the original instrument and introduces the increase in the levy ceiling as intended. To reassure the Committee, in order to prevent future errors of this type, the department has put in place stronger and clearer processes to ensure accuracy in statutory instruments; that is more of a general comment. The department will continue to work with the PPF as it adapts to the changing landscape of defined benefit pension schemes and takes opportunities to enhance its role in the pension protection network.

I turn to the questions raised in much more depth. The noble Lord, Lord Davies, asked—this was added to by the noble Baroness, Lady Sherlock—about the follow-up planned by our department since the publication of the departmental review of the PPF. The departmental review, published in December 2022, made a limited number of recommendations that focused on finding opportunities to enhance the profile of the PPF and take advantage of its expertise. I can reassure the Committee that the department is currently working with the PPF to explore the recommendations and options for implementing them, including the funding of the Pension Protection Fund and improving member engagement. I hope that that gives some answer to the noble Baroness, Lady Sherlock, who asked whether we had responded; that is where we are at the moment.

The noble Lord, Lord Davies, asked why the Pension Protection Fund does not pay the indexation provided for in the scheme rules. As he will know, the rules on indexation can vary significantly across schemes, so trying to replicate scheme rules would introduce complexity into the broadly standardised indexation rules. The PPF is a compensation scheme and, as such, was never intended to replicate, and I mentioned earlier the balance that has to be struck.

The noble Lord, Lord Davies, also asked how it is fair that the PPF indexes of pre-1997 accruals are so different from more recent accruals. PPF’s indexation rules simply allow for benefits accrued before and after a certain date to be treated differently for the purposes of indexation, which broadly reflects the statutory requirements for defined benefit pension schemes. There is no statutory requirement for defined benefit pensions relating to service before April 1997 to be increased when in payment, apart from any guaranteed minimum pension element.

The noble Lord, Lord Davies, and my noble friend Lady Altmann alluded to the point about why the Government do not legislate to introduce indexation on pre-1997 accruals. I think I may have alluded to this earlier, but changes in the indexation rules would significantly impact the PPF’s funding strategy and the wider pensions system. Increasing the indexation provided on compensation would incur significant direct costs for the PPF.

The noble Lord, Lord Davies, asked an interesting question about retained EU law, particularly in respect of the Hampshire judgment. I can give a short answer which I hope may be of help to him, which is that the Government intend to retain the Hampshire judgment beyond the sunset date. I hope that gives him the answer that he was looking for—there is a nod there, which is helpful to me.

The noble Baroness, Lady Drake, asked a number of questions, the first being what consideration our department has made of the fall in the levy population as a product of the rise in the number of schemes buying out. I think that that was the gist of her question. Stronger regulation has led to scheme funding positions improving significantly in recent years, and the department and the PPF have been considering the implications for the pension protection levy. Maybe I can give some assurance by saying that early discussions between the two organisations have focused on the potential rebalancing of the levy, so that it is more aligned with the evolving universe of defined benefit schemes that the PPF is there to protect.

The noble Baroness, Lady Drake, also asked about the materiality of increasing the indexation of the PPF payments above the 2.5% cap, and I believe that that theme was raised by one or two other Peers. Increasing the indexation provided on compensation would incur significant extra direct costs, as mentioned earlier. The deficits of eligible schemes that use the PPF levels as a way of measuring funding would increase, and therefore the size and likelihood of future claims would grow. I alluded to this in my main speech; I am afraid I cannot add much more to what I have already said.

The noble Baroness, Lady Drake, asked what consideration the department has given in terms of the increasing maturity of the PPF and the resulting changes to its cash flow—a slightly different question. The PPF new funding strategy recognises that its population is maturing and seeks to provide security for its current membership, while holding adequate assets for its future claims. Its investment portfolio is aimed to ensure that it has a stable, long-term cash flow for its current membership, while growing its reserve over a period of time.

My noble friend Lady Altmann asked about financial assistance from the financial assistance scheme and, linked to that, there was a theme about improving the generosity of the scheme. A brief answer is that the indexation rules on financial assistance are broadly in line with the legislation for pension schemes more widely but, further to this, the financial assistance scheme is funded from general taxation and thus this balance—this goes back to this balance—has to be struck between the interests of members of the schemes which are unable to secure their liabilities and the wider taxpayer interests.

As regards a question that my noble friend asked about how much remains of assets transferred from the financial assistance schemes to the Treasury, that is a very specific question on which I will have to write, which I am very happy to do.

The noble Baroness, Lady Drake, asked about DWP’s plans for improving transparency of the PPF’s funding and indeed the levy. The PPF publishes its annual report and accounts and consults on the basis on which it collects the levy. That is the answer I have, and I will consider that and look at Hansard later and see whether I can expand on it.

[Baroness Drake (Lab)]

I appreciate that there is a lot out there, but there are three elements: the scope for raising the levy, the compensation levels and the resilience of the PPF over time. Clearly, there is a sort of inflection point for revisiting and managing that. It was just about understanding that and getting more transparency around it.

[Viscount Younger of Leckie (Con)]

Absolutely. That plays well into what I said in that I will reflect on what I and the noble Baroness have said, and there may well be a letter coming to add to the one that I will send to my noble friend.

I will address a couple more questions before I wind up finally. The noble Baroness, Lady Drake, and indeed the noble Baroness, Lady Sherlock, asked whether the PPF is right to build reserves at a slower pace than it has been doing. It is a fair question but that is, as the noble Baroness will expect me to say, very much a matter for the PPF board.

On whether there will be an update on the levy discussions, I may have alluded to this earlier—it was raised not only by the noble Baroness, Lady Drake, but by my noble friend Lady Altmann and indeed the noble Baroness, Lady Sherlock. I will certainly happily make inquiries, and that will be an addition to the letter which is growing bigger by the moment. There may be some other questions that I have not answered, but I will certainly look very closely with my team at Hansard.

To conclude, again I thank the noble Lord, Lord Davies, for providing us with this opportunity to discuss the UK’s flexible and robust regime for funding and protecting defined benefit pensions, which, as was mentioned, is an important subject. This regime has enabled most schemes to weather the severe economic downturns following the crash in 2007-08—the financial crisis, I should better call it—and the Covid pandemic, as well as the prolonged period of historically low interest rates. In fact, the aggregate scheme funding position on a Pension Protection Fund basis improved from 83.4% on 31 March 2012 to 113.1% on 31 March 2022 —an interesting statistic to reflect on. These improvements to scheme funding mean that fewer and fewer members of DB schemes will require the safety net of the PPF. That is of course good news for members, who are increasingly likely to receive their full pension entitlement. This is progress indeed but there is more to do, although of course we cannot eliminate all risk. When employers become insolvent, the PPF continues to stand by as a well-funded and responsibly managed safety net.

[Lord Davies of Brixton (Lab)]

I thank the Minister for his detailed and considered response to what I have certainly found a useful debate. I just need to say that I do not think that the issue will go away. As I suggested, the attrition of members’ benefits will continue, and pressure to do something will get stronger. It would be useful if a meeting could be organised—it is probably just as easy to do it directly with the PPF, but Ministers and officials might like to be involved in it as well, so I will write and suggest that. I thank the Minister again for his attention to this important topic.

Motion agreed.

Committee adjourned at 7.29 pm.