There are two parts to how the levy is calculated. The scheme-based levy, based upon scheme liabilities, is paid by all eligible schemes. The second element, the risk-based levy, takes account of scheme funding, insolvency and investment risks.
The higher the risk that your scheme will be unable to meet its pension obligations or that the sponsoring employer could become insolvent, the higher the risk-based levy your scheme will pay.
The specific factors we use to calculate the levy are set out by legislation under the Pensions Act 2004, known as the ‘levy rules’. We review and consult on how we apply these rules each year.
The factors we use to calculate the risk-based levy
In the majority of cases, our partner Experian assesses how likely it is that your scheme’s sponsoring employer(s) will become insolvent and calculates an insolvency risk score at the end of each month.
When we calculate your levy we’ll average the relevant monthly scores to place your company into one of ten levy bands. Each levy band has a different levy rate. For multi-employer schemes, we take account of all employers to create an average insolvency risk for the scheme as a whole.
If your employer has a public credit rating we use that to make the assessment. We also use the S&P Credit Model to calculate the insolvency risk for certain regulated financial service employers. A small number of employers are assessed as Special Category Employers and assessed outside the standard Insolvency Risk assessment options.
Your scheme’s underfunding risk
We also take into account how well your scheme is funded. We do this by looking at the value of your scheme's assets and liabilities reported on the most recent section 179 valuation for the scheme after making standard adjustments.
We call this your ‘underfunding risk’ and we calculate it based on information that your scheme provides by the end of March via your section 179 valuation in your annual scheme return to The Pensions Regulator.
As financial markets are always changing, we average out the value of your assets and liabilities - known as smoothing - based on the past five years financial market averages.
Read more about providing us with your scheme data
Your scheme’s investments risk
We also apply stresses to your scheme’s assets and liabilities to assess the extent to which those values could be affected by differing investment strategies; in other words, the extent to which the scheme invests in more or less risky assets.
Some schemes are required or choose, to do a bespoke stress calculation showing how their investment risk affects the value of their assets. The threshold for a scheme being required to complete this calculation is currently £1.5 billion of liabilities.
Additional payments you’ve made
If your scheme has a funding shortfall, you may be making additional ‘deficit reduction contributions’ every year to reduce it.
If these payments meet certain conditions and you certify them, they can reduce the level of scheme underfunding and consequently the levy your scheme pays.
Assets that have been promised to your scheme
If assets have been promised to your scheme in the event of insolvency – known as ‘contingent assets’ – they can also reduce the levy. They’ll need to meet certain conditions and be certified correctly.
The levy scaling factor
In order to protect all current and future members, we calculate how much levy we need to collect each year from all schemes. In 2018/19 this was estimated at £550 million. To be sure we collect the appropriate amount we apply a levy scaling factor across every invoice. In 2018/19 this scaled down the amount each scheme would have otherwise been charged by 0.48.
Do all schemes pay the risk-based levy?
There are schemes which, following our standard adjustments, have assets and scheme reduction measures that match or exceed their scheme liabilities. Such schemes will not have to pay the risk-based levy but will have to pay the scheme-based levy.
How the scheme-based levy is calculated
All eligible schemes pay the scheme-based levy. We calculate this by taking the liabilities reported on the most recent s179 valuation, making standard adjustments – though not stressing – and applying the scheme based multiplier of 0.000021.