The Occupational Pensioners’ Alliance 26 March 2008 Pension Protection Fund – Where Are We Now?

1. The Occupational Pensioners’ Alliance26 March 2008Pension Protection Fund – Where Are We Now? Peter Walker – Director of Delivery

2. CONTENTS • What were we set up to do? • Are we doing it? • How will we pay for it?

3. Introduction

4. What the PPF means: “Life is not fair. But there can be few crueller fates than that suffered by those who spend their entire career contributing to a company pension scheme only to find their retirement plans ruined by the business’s financial difficulties.” Financial Times (October 2005) “We were very lucky that the Pension Protection Fund has set up just before the collapse and we have the good news today that it will be taking over the payments to Rover pensioners. I now receive much more than I would have got if the PPF did not exist.” MG Rover pensioner (March 2007)

5. Introduction:What is the Pension Protection Fund? • Public Corporation run by a Board of Directors - derives its powers from, and set up by, the Pensions Act 2004 • Sponsored by the Department for Work and Pensions • Accountable to Parliament through the Secretary of State for Work and Pensions • Pays compensation to members of eligible defined benefit and hybrid schemes which are underfunded and whose employers have experienced a qualifying insolvency event on or after 6 April 2005

6. Balancing Stakeholder Issues Affordability Employers Small, predictable levy Funding, Strong employer covenant Trustees Scheme Members PPF Safe, orderly wind-up Security Short and professional wind-up Security through fully-funded PPF Government Stability

7. Introduction:The current position of the PPF • 12 million DB scheme members protected by the PPF (Purple Book) • Over 50 schemes with over 20,000 members are expected to have completed assessment in the year to 31 March (and about 95 next year) • Over 200 schemes with 120,000 members currently in a PPF assessment period • Over £400m in s75 recoveries made from insolvent employers and paid into schemes • £5bn gross balance sheet total – growing fast

8. The DB Pensions System post April 2005: Who does what? • Responsible for: • Policy • Overseeing the organisations created by the Pensions Act 2004 • Financial Assistance Scheme • to protect the benefits of members of work-based pension schemes • to promote good administration of work-based pension schemes • to reduce the risk of situations arising that may lead to claims for compensation from the PPF To pay compensation to members of eligible pension schemes, which are underfunded, and where there has been a qualifying insolvency event Independent non-profit organisation, funded by DWP, that provides free information, advice and guidance on the whole spectrum of pensions covering State, company, personal and stakeholder schemes. The Pensions Ombudsman investigates and decides complaints and disputes about the way that pension schemes are run. The PPF Ombudsman is the same person providing a similar role for the PPF

9. The DB Pensions System post April 2005: How the PPF works with other bodies • Close working relationship with the Pensions Regulator • Specific objective to protect the PPF • PPF has no regulatory role • Shared data collection via scheme returns • Improvements in scheme funding and governance will reduce risk to the PPF • Joint development of training (e.g. trustee toolkit) • Stewardship from DWP, avenue for legislation • Responsibility of trustees for schemes both ongoing and in assessment

10. Pensions Universe Risk Profile (PURPle Book) published annually by PPF and the Pensions Regulator Tracks some 7,800 eligible DB pension schemes with some 12 million members Highlights: 61% schemes closed to new members or new accruals 63% of members are in open schemes 35% of schemes are in the manufacturing sector (as against a 14% share of the economy) PPF 7800 Index tracks the movement in scheme funding on a month by month basis on a PPF funding basis (buyout, mortality, discount rates) Who does the PPF protect? The PPF Universe: The Purple Book and PPF 7800 Index Estimated S179 Aggregate Balance Total Assets Less Total Liabilities 150 100 50 0 £ billion -50 -100 -150 -200 Jun-06 Jun-07 Jun-03 Jun-04 Jun-05 Dec-06 Dec-07 Dec-02 Dec-03 Dec-04 Dec-05

11. Rescue Insolvency Buyout Enter Assessment Compensation Rejection Validation Assessment Transition Compensation How do schemes enter the PPF?Overview of the Assessment Process

12. Rescue Insolvency Buyout Enter Assessment Compensation Rejection Compensation Validation Assessment Transition Validation • Insolvency Practitioner required to notify PPF of any employer’s insolvency event where there is a pension scheme (Section 120 Notice) • Looking to automate most rejections during 2008 • PPF will then assess whether the scheme is eligible for the PPF • Examples of ineligibility: • DC scheme • Commenced winding up prior to 6 April 2005 • Actions by trustees prior to insolvency

13. Volumes of s120 notices received

14. Rescue Insolvency Buyout Enter Assessment Compensation Rejection Compensation Validation Assessment Transition Assessment • Guide trustees on requirements of Pensions Act 2004: Trustees remain responsible for running scheme and continue to pay benefits at PPF levels • Agreement of a plan for: • Data Cleansing • Confirmation of Membership Data (NISPI etc.) • Production of a s143 valuation • Liaison with Insolvency Practitioner in creditor role to recover s75 debt for the pension scheme • Working with trustees to project-manage the scheme through assessment

15. Rescue Insolvency Buyout Enter Assessment Compensation Rejection Compensation Validation Assessment Transition Transition • Valuation of scheme carried out according to Section 143 of Pensions Act 2004 • Valuation on a buyout basis • Consultation launched last month on assumptions used • Values assets and liabilities at insolvency date (including s75 recoveries) • Assesses whether scheme could secure benefits equal or higher than those provided by the PPFby buying out

16. Rescue Insolvency Buyout Enter Assessment Compensation Rejection Compensation Validation Assessment Transition Compensation • If funded above PPF levels – Scheme buys out • Scheme must still seek to wind up • Trustees will seek to secure benefits above PPF levels • Benefits may still be below full levels (Priority order applies) • If funded below PPF levels – Scheme enters the PPF • Transfer of member data to Capita • Scheme assets transfer to PPF • PPF takes responsibility for ongoing and future payments • Remaining liabilities extinguished (AVCs, DC elements etc.) • Trustees are discharged

17. Forecast of transfers into PPF including current year rescues

18. What the PPF pays:Compensation • Compensation (not pension) is paid to members; not dependent on the assets that were in the scheme • Set by the Pensions Act 2004 • Two levels of compensation • 100% compensation • 90% compensation (subject to a cap)

19. What the PPF pays:Compensation • 100% of their pension in payment at the assessment date is paid to: • Those over the scheme’s normal pension age at assessment date • Those under the NPA but receiving an ill health pension at the assessment date • Those receiving a survivor’s benefit • 90% of pension entitlement (subject to a cap) at the assessment date paid to: • Those who’ve not started drawing their pension at the assessment date • Those receiving a pension but below the pension scheme’s normal retirement age (but not an ill-health or survivor’s pension at the assessment date (i.e. early retirees) • Annual revaluation is applied to deferred entitlements and it is based on RPI capped at 5% • Annual indexation in payment is applied to post ‘97 service entitlements and it is based on RPI capped at 2.5%

20. How the PPF is funded Three sources of funding: • Investment returns • Taking in the remaining assets of pension schemes for which it assumes responsibility (including recoveries) • Raising an annual pension protection levy on all eligible defined benefit and hybrid schemes

21. Cash - 20% Global Bonds Currency - - 50% 2.5% Property - 7.5% Global Equities - UK Equities - 7.5% 12.5% How the PPF is funded:PPF Investment Strategy • Bespoke • Unique nature of PPF • Both pension fund and insurer • Uncorrelated with schemes to which PPF exposed • Dynamic • Liability profile constantly evolving • Liability Driven • Context of compensation levels • Indexation changes liability over time

22. Baseline scenarios Distribution issues Investment/Risk Solvency targets Economic/ Behavioural evidence Risk based levy Long Term Risk Model Baseline and alternative scenarios Scheme based levy Scheme data How the PPF is funded:The levy and the Long Term Risk Model

23. How the PPF is funded:The levy • Overall levy quantum to be collected based on Long Term Risk Model; set by Board • £675m for 2007/08 and 2008/09; indexed to wages for next two years • Distribution between schemes based on risk: • Scheme based levy (20%) • Proportion of scheme liabilities • Risk based levy (80%) • Insolvency risk: probability of employer insolvency in next year • Underfunding risk: funding position of scheme on S179 basis • Levy structured to encourage risk reduction • Tapered reductions in levy payable for well funded schemes • Recognition of voluntary steps such as deficit reduction contributions and contingent assets • Levy cap limits annual levy payment for weaker schemes

24. How the PPF is funded:Developing the levy – long term risk Short-term approach Hybrid approach Future development of the levy 05/6 06/7 07/8 08/9 09/10 10/11 11/12 Quantum Basis Distribution Basis Long Term Risk Short-term risk Long Term Risk Short-term risk Long Term Risk Adapting 07/8 towards L/T basis Long Term Risk Review of 08/9 basis LTRM & Economic Capital LTRM & Economic Capital Start-up Fund No. of Members Further consultation on approach to long term pricing

25. Scheme investment risk • The PPF has monitored the implications for risk • Consulted in 2007 • Concluded time was not then right for inclusion as a risk factor • Committed to continuing to monitor the situation • Importance of scheme investment strategy for long term risk – both for modelling and pricing • KPMG on behalf of the PPF conducted a survey of a number of large UK pension schemes in December 2007 • 95 pension schemes with approximate assets totalling £191bn responded

26. Evidence from NAPF surveys • 2006 NAPF Annual Survey • 17% DB schemes using an LDI strategy • 30% considering adopting LDI • 53% not using or not considering • Survey did not seek to define LDI • 2007 NAPF Annual Survey • Fall in equity share of total assets from 59.7%to 56.3% • Fixed income share to 29.4% from 27.7%

27. Evidence from PPF survey 45% Percentage of liabilities • Many of the schemes estimate that only a small proportion of the scheme liabilities have been immunised/matched or hedged by investments in bonds (and/or derivative overlays) • Where a scheme hedges a large proportion of the liabilities, funding tends to be nearer to 100%. Where funding is significantly above or below 100%, the proportion of liabilities hedged is significantly lower 39% 40% hedged 35% 30% 22.6% 25% 20% 14.4% 15% 10% 6.6% 6.2% 5% 2.6% 5% 1.8% 1.4% 0.5% 0% 0-10% 61-70% 71-80% 81-90% 11-20% 21-30% 51-60% 31-40% 41-50% 91-100%

28. Evidence from PPF survey Future plans on hedging interest rates and inflation • 38 schemes use swaps • Half of these allow their active bond manager the freedom to enter into swaps to better manage their portfolio • Only 12 of the 38 employ swaps to specifically hedge interest and inflation risks • Of the remaining 57, 28 schemes have formally considered the use of swaps in managing exposure to interest rates and inflation None Over next 10 years Over next 5 years Over next 3 years Over next year None - complete 0 20000 40000 60000 80000

29. Any questions?Pension Protection Fund – Where Are We Now? Peter Walker – Director of Delivery