Tuesday, 16 January 2018

Getting to Know the Pension Protection Fund

The last post of Financial Regulation Matters looked at the then-ongoing crisis at Carillion; now we know that the firm could not survive the crisis, with the situation being that an official receiver was appointed to liquidate the company immediately. Whilst this author is not of the habit of agreeing with Andrew Adonis, his recent likening of the situation to the Enron scandal, in terms of the extent of the scandal and who it will ensnare as it develops, seems to be an accurate depiction; our old friends KPMG are currently being scrutinised for providing positive audits just months before the firm spectacularly collapsed – no doubt, many financial (and political) players will be implicated as this remarkable corporate collapse continues to come to light. However, whilst Carillion and the collapse will be revisited in this blog and, no doubt, fill the business media for weeks to come, this post will take a different approach and use the story to better understand a different type of organisation – the Pension Protection Fund (PPF).

In the Financial Times yesterday, a headline read ‘Carillion pension schemes transfer to industry lifeboat’, which the ensuing story confirming that ‘around 28,000 members of Carillion’s 13 UK Pension schemes will now be transferred to the Pension Protection Fund… Pension scheme members… will receive 90 per cent of the pension they were expecting, up to a cap’; in February 2017, the same assistance was offered to pension holders at the collapsed High-Street store BHS. The PPF is therefore (a) an important component in the financial landscape in the U.K., and (b) may see its importance grow as other firms flirt with collapse like Carillion has been; so, assessing its composition, aims and objectives, and place within the overall framework will be a useful endeavour. Born out of the Pensions Act 2004, the PPF was established in April of 2005, with its stated mission now being to ‘provide compensation to members of eligible defined benefit pension schemes, when there is a qualifying insolvency event in relation to the employer, and where there are insufficient assets in the pension scheme to cover the PPF level of compensation’. To fund this endeavour, the PPF has several defined sources of income, including an annual levy paid by all eligible pension schemes, recovery of money and assets, and returns on investment. In terms of its composition, the PPF is run by a Board, which is responsible for paying compensation, calculating levies, and setting investment strategies and include figures such as Arnold Wagner (Chairman) and Alan Rubenstein (CEO). Now that we know a little bit about the Fund, looking at how it operates provides a useful foundation to ask further questions, with the first point to note being that having this protection, from one specific viewpoint, is an extremely positive development. When we look at how the Fund managed the BHS situation, whereby the owners (and past owners) had pilfered the pension pot of that once-illustrious company, we can see that the Fund is very keen to promote the perceived independence of the initiative, with them consistently declaring to what-would-be worried BHS pension holders that they have been transferred into a scheme which is both very fair to them in terms of what they will be entitled to, and that the scheme has absolutely nothing to do with the firm’s previous management – ‘It will have independent governance and neither Sir Philip Green nor the Arcadia group will be involved in the management of the scheme’ is a definitive and revealing statement. Yet, the situation with Carillion, at the moment at least, is raising a whole host of questions about the Fund and its capabilities.

Whilst the figures being quoted for the impact that the PPF will have to absorb from Carillion’s collapse vary, they are all substantial. The Economist predict that the total impact could be close to £900 million, whilst other outlets predict between £587 and £800 million. According to the PPF’s last annual report, the Fund is operating with a reserve of just over £6 billion which means that whilst the Carillion hit will certainly not critically damage the Fund – meaning that headlines like ‘will pensions still be paid’ are slightly misleading – a minimum impact of £587 million is not insignificant, as the chances of clawing back some income from the Carillion rubble seem to be more remote by the day; the PPF was particularly reluctant to engage with the salvaging efforts of Carillion (its suggestion of transferring debt into shares would have made the PPF a major shareholder in the firm) which is looking to be a particularly astute call. However, whilst it is positive news that Carillion’s pension holders have this safety net to rely on, the situation raises another, more systemic question.

When a company fails, one of the biggest issues for its management is the pension pot – the reason for this, in one particular sense at least, is that the backlash will be amplified if the pension pot is drained in addition to the funds of the company, because shareholders are categorised, in the general public’s perceived persona at least, to be accepting of the risk of loss whereas pension holders are considered to be innocent victims in the arrangement; this was clearly demonstrated in the overly-public rebuking of Sir Philip Green’s treatment of the BHS Pension Pot. Yet, if we were to flip the focus, what does the PPF mean to corporate management? Whilst it means safety to pension holders, it means another layer of safety net with which directors can take greater risks for short-term rewards; today it was stated in the media that ‘the Government has ordered a fast-track investigation into directors at the failed construction firm Carillion’ but the chances of that culminating in anything more than a sacrificial lamb being offered up are extremely remote (the Government’s own complicity will no doubt be left out of that investigation). So, we know that an extra layer of protection will likely result in increased negligence from corporate management (Carillion being the case in point), and we have discussed on many occasions that the only real antidote is to alter the perception of what ‘crime’ is so that corporate crime is punished just like ‘conventional’ crime – the chances of risk taking would be instantly reduced. Nevertheless, it is difficult not be conflicted when assessing the PPF, because it is extraordinarily important as pension holders, who are often disproportionately incentivised to contribute to corporate schemes by way of corporate and governmental inducements, should not face having to lose everything because of corporate negligence. Yet, the extra layer of protection adds to other layers which make it extremely easy, particularly when paired to a lax punitive system for corporate crime, to commit corporate transgressions – now the moral dilemma of destroying pensions has been, effectively, removed in most scenarios (there are not many pension schemes which could deplete the PPF’s reserves single-handedly). The cyclical notion of that understanding results in the realisation that until corporate crime is properly designated as crime, very little will change.

Keywords – Carillion, Pension Protection Fund, Politics, Business, Corporate Crime, BHS, @finregmatters.

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