The security of workers’ pensions is a matter of concern whenever a defined benefit pension scheme’s sponsoring employer could become insolvent. Defined benefit pension schemes are ultimately a promise to provide a pension in line with the pension scheme rules. The benefits are guaranteed by the sponsoring employer, this guarantee ends when the sponsoring employer becomes insolvent.
The reason that losing a sponsoring employer is problematic is because a lot of defined benefit schemes are underfunded and rely on the sponsoring employer to make recovery payments to increase the funding level of the scheme. If the sponsoring employer is insolvent, they cannot make those payments and there aren’t sufficient assets in the scheme to pay all of the liabilities.
Pension schemes are funded in advance by employee and employer pension contributions. However with defined benefit schemes the exact cost of providing these benefits cannot be determined in advance. The scheme has to meet any costs that occur due to lower than expected investment returns and increasing life expectancy. Actuarial valuations of the scheme take place every three years. They determine the future level of employer contributions, the funding level of the scheme and schedule for recovery payments.
The Pension Protection Fund (PPF) was established in April 2005 as a lifeboat for UK based defined benefit pension schemes when the sponsoring employer becomes insolvent to ensure that even in the event of insolvency, pension scheme members get a minimum level of compensation.
Not all schemes will enter the PPF after employer insolvency. Schemes with assets that could purchase pensions with an insurance company that would provide a higher level of benefits than PPF compensation will not enter the PPF. In this scenario members could still get lower benefits than they were originally entitled but higher benefits than the PPF provides.
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