Compensation for members of insolvent pension schemes will be linked to service, says Government

The cap on compensation payable by the Pension Protection Fund (PPF) to members of insolvent defined benefit (DB) pension schemes who have not yet retired will be increased by 3% for every year of service over 20 years, it said.

Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that there was "some justice" in adjusting the cap to "recognise the differences" between longer-serving workers approaching retirement age and those who had just joined a scheme.

"For some members, payments from the PPF may represent the only pension they built up over a long period of work. Others may only have worked for a couple of years for the employer whose pension scheme has been tipped into the PPF," he said.

"However, tweaking the system so late in the day is far from ideal. And the employers who pay the PPF levy will want to know exactly how much more they'll have to pay," he said.

The PPF is funded by an annual levy paid by eligible DB pension schemes. The estimated total levy for 2013-14, as proposed by the PPF in September, is £630 million. The fund provides compensation to members of those schemes when the employer suffers a qualifying insolvency event, and where there are insufficient assets in the pension scheme to cover the amount of compensation the PPF would pay.

Length of service of pension scheme members is not currently taken into account when a DB pension scheme is taken over by the PPF. The fund instead pays two levels of compensation, depending on whether the member is over or under the scheme's pension age. Those who are over the pension age at the point of insolvency receive 100% of the benefits they are entitled to. Those who are under scheme pension age are entitled to 90% compensation, which is subject to a cap.

Under the new system, that cap will increase by 3% for every year over 20 years that a worker has paid into the pension scheme. According to Pensions Minister Steve Webb, this will mean that somebody who had contributed to a pension scheme for 40 years and accrued a pension of £50,000 when the scheme was wound up would receive £45,000, rather than the current capped amount of £31,380.

Legislation to make the change would be introduced "as soon as Parliamentary time allows" but the change will not be backdated, Webb said. Those with long service who already receive capped compensation will be entitled to an increase only on those benefits that are paid out once the new laws take effect, he said.

"It cannot be right that someone who has been with a company for much of their working life - and relies heavily on that for their pension income - gets the same in compensation as someone with far shorter service and who could also have other pension income to fall back on," he said.

"I want to ensure that those who are or could be affected will in future have their long service recognised in the form of higher compensation," he said.

The review of how the PPF compensation cap operates was prompted by the collapse of car parts company Visteon in 2009.

Employers' group the Confederation of British Industry (CBI) said that any increases to the PPF levy as a result of changes to the cap would come as a "bitter blow" to member firms.

"The fund is paid for by business, not the Government," he said. "At a cost of over £600m a year, it is already more than double the original plan, and the levy is likely to rise again this year."

"An even greater levy will hold back business investment and growth. Businesses support the PPF, and would have expected more engagement before this announcement was made," he said.