The Pension Protection Fund: What Happens If Your Employer Goes Bust

The UK has one of the most comprehensive occupational pension safety nets in the world. The Pension Protection Fund (PPF) was established by the Pensions Act 2004 and began operating in April 2005, precisely to address the situation that had previously left DB pension members exposed when their employer became insolvent with an underfunded pension scheme.

Before the PPF, the insolvency of a sponsoring employer could mean pension scheme members — sometimes having contributed for decades — received a fraction of their expected benefits, or nothing at all in severe cases. The PPF provides a meaningful floor of protection, though it is not a complete guarantee and there are important limits that members of large final salary schemes should understand.

What the PPF Does

The PPF is a statutory fund that takes over defined benefit pension schemes when the sponsoring employer becomes insolvent and the scheme is underfunded relative to its PPF-level liabilities. It is funded by annual levies charged to all eligible DB pension schemes in the UK, as well as by assets recovered from insolvent employers.

When an employer becomes insolvent, the PPF does not immediately take over the scheme. Instead, the scheme enters an "assessment period" during which the PPF assesses whether the scheme should transfer to it. This assessment can take months or years. During the assessment period, the PPF pays benefits at PPF compensation levels — it does not pay the full scheme benefits during assessment.

What the PPF Pays

The PPF compensation structure depends on your status at the point the employer becomes insolvent:

If you are already drawing your pension (or have reached the scheme's normal pension age): You generally receive 100% of the accrued pension you were entitled to, subject to the PPF's rules on indexation. (The compensation cap that previously also applied was removed following the Hughes litigation — see below.)

If you are a deferred member (not yet drawing your pension, and below normal pension age): You generally receive 90% of your accrued pension entitlement. (This 90% level still applies; the separate monetary compensation cap that once reduced higher earners' benefits has been removed — see below.)

The reduction to 90% for those below pension age reflects an actuarial adjustment and the constraints of the PPF's funding model. It was and remains a significant point of contention for those affected.

Indexation Within the PPF

Within the PPF, pensions do not increase in the same way as in the original scheme. PPF compensation is increased annually in line with CPI inflation, but subject to:

• A floor of 0% (it will not be cut in deflationary conditions)
• A cap of 2.5% per year

This applies to pension accrued after April 1997. Pension accrued before April 1997 receives no inflation increases within the PPF.

This means that for long-serving employees with significant pre-1997 service, the real value of PPF compensation may erode over time relative to what the original scheme would have paid.

The PPF Compensation Cap (Now Removed)

For most of the PPF's history, a compensation cap was the most significant limitation on PPF protection for higher earners. It applied at the 90% level — capping the "90% of accrued pension" figure payable to those below normal pension age — and stood at roughly £41,000 per year at age 65 at the 90% rate in its final years.

That cap is no longer in force. In Hughes v Board of the Pension Protection Fund, the courts held that the cap unlawfully discriminated on grounds of age; the Court of Appeal upheld this in 2021. As a result, the PPF disapplied the compensation cap and recalculated affected members' benefits with effect from their retirement date, removing the cap and (where relevant) ensuring members receive at least 50% of the value of their originally accrued benefits. Members who had previously had their PPF compensation reduced by the cap have therefore had their entitlement increased, often with arrears.

In practical terms, this means that senior executives and long-serving employees of well-funded schemes — the group most affected by the old cap — are now substantially better protected than they were before 2021. The historic cap should not be relied upon as a current limit. (Separately, before its abolition the cap had carried a long-service enhancement, increasing it by 3% for each complete year of pensionable service above 20 years; this is now of historic interest only given the cap's removal.)

The PPF Levy

Every eligible DB scheme in the UK pays an annual levy to the PPF. The levy has two components:

The scheme-based levy: a flat levy based on the number of members in the scheme.

The risk-based levy: calculated with reference to the scheme's estimated deficit (if any) and the probability of the sponsoring employer becoming insolvent. Better-funded schemes with financially stronger employers pay lower risk-based levies; poorly funded schemes with financially weaker employers pay more.

The levy system is designed to create financial incentives for sponsors to keep their schemes well funded and to price the risk of failure appropriately. Schemes can provide contingent assets (such as charges over company property) to reduce their risk-based levy.

What the PPF Does Not Cover

Understanding the boundaries of PPF coverage is as important as understanding what it does cover.

Defined contribution pensions are not covered. The PPF's mandate is limited to defined benefit and hybrid pension schemes. If you have a DC pension — whether a workplace DC pension, a personal pension, or a SIPP — the PPF provides no protection. DC assets are held by the pension provider (typically a regulated insurance company or platform), not by the sponsoring employer, and so the employer's insolvency does not directly affect them.

Personal pensions and SIPPs have separate protection. DC pensions held with regulated UK pension providers may be covered by the Financial Services Compensation Scheme (FSCS) up to applicable limits if the pension provider itself becomes insolvent — but this is a separate protection scheme with different rules, and the protection depends on the structure of how assets are held.

Enhancements above scheme rules. If an employer promised informally to pay above what the pension scheme rules specified, those promises are not covered by the PPF. Only benefits accrued under the formal scheme rules are protected.

Discretionary increases. Some DB schemes paid discretionary increases to pensions above the minimum required by law. The PPF does not pay discretionary increases — only the contractual accrued benefit.

The Assessment Period

When an employer becomes insolvent, the pension scheme enters an assessment period rather than immediately transferring to the PPF. During the assessment period:

• The PPF takes on responsibility for the scheme
• Benefits are paid at PPF compensation levels (not full scheme levels)
• The PPF assesses whether the scheme has sufficient assets to secure PPF-level benefits with an insurance company, or whether it should formally transfer to the PPF
• Trustees remain in place but work alongside the PPF

Assessment periods vary considerably in length. Complex cases involving large schemes, ongoing legal proceedings, or disputed asset valuations can last several years. For members, the uncertainty during assessment — receiving reduced benefits with no guarantee of how long the period will last — can be stressful.

If the scheme is found to have sufficient assets to secure benefits at PPF compensation levels with an insurance company, it will be "rescued" and members will receive their benefits from the insurer rather than the PPF. This is known as a "scheme rescue."

The Financial Assistance Scheme

For members of schemes that fell through the cracks before the PPF existed, the Financial Assistance Scheme (FAS) provides equivalent protection. The FAS covers members of DB schemes that wound up underfunded between 1 January 1997 and 5 April 2005 — the period after the PPF was first proposed but before it began operating.

The FAS pays a broadly similar level of protection to the PPF: at least 90% of expected pension benefits, subject to a cap. It is administered by the PPF on behalf of the government but is funded by the government rather than by industry levies.

For schemes wound up before 1997, the position is more complex and individual circumstances vary. Former members of schemes in this category should seek specialist advice.

Implications for Expats

For UK nationals living abroad who have deferred DB pensions from former employers, the PPF provides an important backstop. However, there are practical points to note:

Keep your address updated. The PPF and scheme trustees need to be able to contact you. If you have moved abroad and not updated your address with the scheme administrator, you may not receive notifications about the employer's financial position or, critically, the scheme entering assessment.

Monitor your former employer. If you know a former employer that runs a DB scheme is in financial difficulty, it is worth actively checking the PPF register and contacting the scheme trustees.

The old cap no longer bites. The PPF compensation cap that once limited higher earners' benefits was ruled unlawful and removed following the Hughes litigation. If you have a large accrued DB pension, your PPF compensation is no longer subject to that monetary cap — though the 90% level (for those below normal pension age at insolvency) and the PPF's indexation rules still apply, so PPF compensation may still fall short of the full original scheme benefit.

Drawdown is not affected. If you transferred your DB pension out before the employer's insolvency (into a SIPP or QROPS, for example), the PPF does not apply. The pension is already in your own arrangement and is unaffected by the employer's subsequent failure.

How Global Investments can help

If you have a deferred defined benefit pension from a UK employer and you have concerns about the employer's financial health, or if you are considering whether to transfer out of a DB scheme in part because of employer covenant concerns, Global Investments can provide independent analysis.

We can help you understand the level of PPF compensation you would actually receive (including the effect of the 90% level and PPF indexation, now that the old compensation cap has been removed), model the financial case for transfer versus retention, and ensure that any decision is made with a clear view of the full range of risks on both sides. Transferring out of a DB scheme is irreversible, and the decision should not be driven by employer covenant concerns alone — but they are a legitimate factor in the overall analysis.

Contact our pensions advisory team to discuss your DB pension position.