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.
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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.