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15 Jan 2018

Carillion collapse: what will happen to final salary pensions?

Pension Protection Fund is likely to step in which means a 10% cut for some

Carillion, one of the UK government's biggest contractors, went into liquidation today (15 January) leaving its defined benefit (DB) pension schemes likely to fall into the hands of the Pension Protection Fund.

The firm, which provides services to schools, courts and prisons, has 13 DB or 'final salary' schemes in the UK with over 28,500 members.

In these situations the Pension Protection Fund (PPF) can step in to absorb the schemes and ensure members get paid. But for some that means accepting a 10% cut in payouts and even greater losses for higher earners.

Which? explains what the PPF is, how it works and what the compensation limits are.

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What is the Pension Protection Fund?

The Pension Protection Fund was formed in April 2005 under the Pensions Act 2004 to step in when a company goes bust and cannot fulfil its defined benefit pension obligations.

It takes on eligible schemes and pays out compensation to members once the employer becomes insolvent and following an assessment period.

Before the scheme was in place, employees would have nothing if the employer behind a final salary scheme went bust.

Are Carillion's schemes covered by the PPF?

Carillion's DB pensions is likely to qualify for protection by the Pension Protection Fund under the normal rules, but first they will have to go through what is known as the'PPF assessment period'.

During this time, trustees remain in control of a scheme and any payments already being made. The trustees are also tasked with figuring out how much money and other assets are leftover and making sure all member details are up to date.

At the same time the PPF will try to recover what it can from the insolvent employer by acting as a creditor.

The scheme will not be eligible for the PPF's help if it is rescued and a new employer takes on responsibility or the scheme has enough assets or money to buy benefits with an insurance company which are at PPF levels of compensation or above.

At this stage it seems very unlikely this will be the case for Carillion but the final decision on whether or not the PPF should take over the scheme could take a while.

Tom McPhail from Hargreaves Lansdown explained: 'Assuming the PPF does take on theCarillionscheme, the assessment process could take months or even years. In the meantime, theCarillionscheme administrators, the liquidators and the PPF can be expected to work together to ensure continuity of payouts for scheme members.'

How much will the PPF pay?

If the PPF takes on responsibility for a scheme, it takes over making payments to scheme members.

The level of the payments will depend on your status.

If you have retired

If your scheme falls into the PPF and you are already retired, your pension will normally be paid at the exact same level that you got when your employer went bust.

This also applies if you had to retire due to ill health or if you are getting a pension in relation to someone who has died.

If you retired early

If you retired early and had not reached the scheme's normal pension age when your employer went under, you will normally get 90% of what the pension was worth at the time.

As well as being 10% lower, the annual compensation you will receive is also capped at a certain level, which means higher earners stand to lose even more income.

From 1 April 2017, the limit stands at £38,505.61for a 65-year old or £34,655.05when the 90% level is applied per year.

The earlier you retired, the lower the annual cap is set, to allow for the longer time you will be receiving payments. You can check the PPF compensation caps for each age group here.

However, savers with longer service get special protection and the compensation cap is increased by 3% for each full year of service above 20 years up to a maximum of double the usual limit.

If you have yet to retire

When you reach the scheme's retirement age the payments you get from the PPF will also be at 90% the promised rate up to the compensation cap.

Again the cap stands at £38,505.61for a 65-year old or £34,655.05when the 90% level is applied per year.

This means you will be hit by a 10% cut to your pension income when you reach retirement and again higher earners that have not yet retired face a substantially bigger loss as there is an overall cap on compensation.

But again savers with longer service get special protection and the cap is increased by 3% for each full year of service above 20 years up to a maximum of double the usual cap.

Will the PPF payments rise with inflation?

Once the compensation payments start being paid they will rise in line with inflation each year, capped at 2.5%.

However, the increase only applies to pensionable service from 5 April 1997, so payments relating to service before this date will not rise.

Can the PPF afford to take on Carillion's pension schemes?

Carillion reportedly has a pension deficit of £587m, but the PPF has a £6bn surplus so should be able to absorb the scheme and pay compensation under its normal rules.

Where does the PPF get money from?

The PPF is able to take over the assets of the schemes it rescues and recovers what it can from the firms.

It also raises money through the annual Pension Protection Levy, which it charges to the eligible schemes it protects each year.

The organisation also invests the assets of the Pension Protection Fund.

What happens next?

PwC has been appointed as special managers and has now set up a dedicated site with more information for employees and theirpensions that will be kept updated.

The Pension Advisory Services (TPAS) has also established a dedicated Carillion line 0207 630 2715.TPAS will be able to discuss general enquiries members have about their pensions, but not questions about members' specific circumstances.