The state-backed pensions lifeboat is 'a pyramid scheme with a dwindling number of members'

The state-backed Pension Protection Fund (PPF), charged with paying the pensions schemes of collapsed companies, is "a pyramid scheme with a dwindling number of members," a leading commentator has told MPs.

Philip Coggan, a columnist for The Economist, warned MPs investigating BHS' collapse and its pension scheme deficit that the whole system set up to save pensioners in this situation is unsustainable.

In a written submission to the joint Work and Pensions Select Committee and Business Select Committee inquiry into the collapse of BHS, Coggan says:

The PPF is funded by levies on companies offering DB [defined benefit] schemes. Some of these schemes will be run by employers whose business model is struggling (BHS and Tata Steel being two examples). Slowly and surely, they are dropping out of the PPF, leaving their liabilities behind them. That would be OK, if new companies were joining the scheme to provide future funding. But new companies don't set up DB plans.

In other words, the PPF is a pyramid scheme with a dwindling number of members.

Some explanation of what Coggan is saying here: firstly, you need to understand defined benefit schemes. These are pension schemes where members are promised a certain level of payout once they retire. These are increasingly unworkable because people are living longer, meaning employers need to meet these payout levels for longer, and because interest rates are in the toilet, making earning the money to pay the pensions all but impossible.

As a result, no one is setting up defined benefit pension schemes anymore. But, as Coggan points out, the PPF, often called the pensions lifeboat because it rescues schemes, funds itself from levies on remaining defined benefit schemes.

The paradox is that as more companies go bust and leave their schemes to the PPF, it will be forced to put up levies to fund itself. That means more pressure on the already ropey DB schemes, meaning they're more likely to go bust. When they do, they fall to the PPF and the whole vicious cycle starts again.

Coggan is not the only one to sound the alarm over defined benefit pension schemes. In his submission to the inquiry, former pensions minister Steve Webb warned there are hundreds of "zombie" pension schemes that are still stumbling along but have "no realistic chance of the pensions promises being met."

The PPF CEO Alan Rubenstein pointed out the MPs this week that it is overfunded, with a surplus of £3.5 billion. BHS' collapse will not have an impact on levies - it has enough slack to absorb the £300 million shortfall in the department store's scheme.

But Coggan warns: "It is worth noting the combined deficit of the schemes it covers was £302 billion at the end of March. Obviously all those companies will not go bust overnight. But the deficit is up from £70 billion two years ago."

He wants the regulator to do more to force companies to plug deficits in pension schemes, rather than accepting long, unrealistic recovery plans. BHS was committed to a 23-year recovery plan, well above the normal 8 years, which Coggan calls "absurdly optimistic. The cash payments it was making to close the deficit were not covering the cash outlays to pensioners." In other words, even under the recovery plan the balance was going down.

Coggan says the regulator should be able to block executive pay and publicly "name and shame" companies not meeting the shortfall. He writes:

Intervention should be public, with the Regulator empowered to stop the payment of dividends or executive bonuses. Employees should also be notified so they can transfer their assets into DC schemes and avoid the potential cuts that might occur under the PPF. BHS employees might have saved money if they had been aware of the dire nature of the scheme's finances. The committee should consider whether future employees of other failing companies could be saved from the same fate.