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PPF not required to increase compensation to 100%: Court

PPF not required to increase compensation to 100%: Court

British pension plans dodged a bullet when the European Court of Justice ruled that an industry-financed reserve fund for employees of bankrupt companies is not required to pay benefits equaling 100% of expected pensions.

Even so, industry analysts say the ECJ's decision to send the case back to Britain's High Court to determine retirees' level of compensation in line with European Union directives could mean accelerating payouts from the U.K. Pension Protection Fund. The cost of 100% compensation could be as high as £3 billion ($5.91 billion), according to industry experts.

Should the High Court decide that the fund's current 60% to 70% compensation level does not comply with E.U. directives that require adequate protection for retired workers, increasing payouts could drain the fund and force the British government to sharply increase levies on remaining pension plans, which in turn could send more into insolvency.

"I think the odds of a sharp increase have gone down," said Stephen Yeo, a senior consultant in the London office of Arlington, Va.-based Watson Wyatt Worldwide. "There was a fear that the ECJ would say (compensation should be) 100%, and then increases would have been definite."

But with the court's decision, "it's definitely possible that the High Court would say that what you have is all right, or as a fallback position, say you need a little change here or there," Mr. Yeo said.

The PPF, established in 2004, provides compensation to members of defined benefit pension plans known as "final salary" schemes that lack sufficient funds to pay their members when a company becomes insolvent.

Based loosely on the U.S. Pension Benefit Guaranty Corp., the guaranty fund is financed by a pension plan levy that is based on a combination of a company's underfunding of its own pension plan, how much risk there is of a company becoming insolvent and contingent assets that have been put in place by the pension plan, capped at 0.5% of liabilities.

In 2007, the government expects to collect £675 million ($1.33 billion) in levies for the PPF, £540 million ($1.06 billion) of which is risk-based. That is an increase from £575 million ($1.13 billion) in 2005.

Employees younger than retirement age receive 90% of their pension when they retire and, at most, they receive £26,050 ($51,282) annually on retirement at age 65, meaning employees expecting higher pensions receive less protection to ensure that there's enough money in the fund at current levy rates.

Sufficient protection

Employees of steel company ASW Ltd. sued the government and claimed two members received just 20% and 49% of expected benefits from the PPF, and that constituted insufficient protection of retired employees under E.U. directives.

The British High Court referred the case to the European Court in 2005, seeking clarification on what constitutes compliance with E.U. directives.

The European Court ruled that the PPF does not need to increase compensation to 100% of expected benefits. However, it added that 49%, as was the case with one of the ASW workers, "cannot be considered to fall within the definition of the word 'protect"' stated in E.U. directives.

"Companies with defined benefit pension schemes can breathe a sigh of relief that (the) judgment did not rule that accrued benefits must be met in full," said Paul McGlone, a principal and actuary in the London office of Chicago-based Aon Consulting, in a statement. "Such a ruling would have led to enormous hikes in future PPF levies, over and above the increases in levies introduced for 2007/08."

The cap for the industry levy is increasing to 1.25% of liabilities this year. Because of the structure used, some pension plans are seeing their levy increase fourfold this year, Mr. McGlone said.

According to Aon, if every U.K. employer became insolvent, the PPF would have £76 billion ($149.6 billion) in liabilities. Raising the requirement to 100% of benefits would have increased that amount to £440 billion ($866.2 billion).

The remaining question is the High Court's judgment of how well the British law complies with the E.U. directive. If the High Court finds the law to be in "manifest and grave" disregard of the directive, then the PPF will have to increase payments to retirees.

"This is still high-stakes poker," Tim Keogh, a worldwide partner in London for New York-based Mercer Human Resource Consulting, said in a statement. "As it stands, the U.K.'s pension system is only sustainable if scheme members continue to accept a degree of risk. If the U.K. High Court finds the PPF still leaves too much risk in the system, the bill for avoiding future claims could run into billions, further accelerating scheme closures."