David Prosser's Outlook: No prizes for pension prudence

No wonder companies keep closing their final salary pension schemes. The premiums employers must pay into the Pension Protection Fund, set up to protect members of schemes run by companies that go bust, will be more than twice as high as the compensation scheme itself had suggested last November. And what will particularly aggrieve many finance directors is that they appear to have been victims of their own prudence.

The PPF raises money in a rather peculiar fashion. Some 20 per cent of its annual levy comes from fees charged to schemes on the basis of their size. The other 80 per cent is a risk-based levy, with premiums based on how well-funded a scheme is and the likelihood of its employer falling into insolvency. There is thus an incentive for employers to keep their schemes well funded – the carrot is a lower PPF levy.

Trouble is, the PPF works out how much money it needs each year before taking a detailed look at the assets and liabilities of individual schemes and their employers. Last November, it decided £675m was the magic figure for 2008-09, only to discover that employers had improved their schemes' funding positions so markedly that the risk-based levy formula would produce a substantial shortfall.

No matter. The PPF warned in November that it expected to have to scale up schemes' bills once it worked out the detail of the risk-based levy. At the time, it reckoned a factor of 1.6 was realistic, but yesterday announced the number required was 3.77.

To put this another way, employers with final salary pension schemes will now have to pay a risk-based levy – remember, this accounts for 80 per cent of the total PPF annual charge – that will be 2.36 times higher than the fee they were expecting only six months ago. All because they have funded their schemes more generously than the PPF had allowed for.

The PPF's justification for what appears to be an injustice is that while scheme funding has improved in the short term, it must protect against long-term risk. That may be, but many employers will feel cheated by this arrangement. Had they not improved scheme funding, their bills would have been even larger of course, but the huge fee increases they face hardly represent the juiciest of carrots.