Laura Blows explores how rising pension deficits have been putting pressure on the charity sector

Defined benefit schemes closing in some shape or form, be it to new members, future accrual, or wound up completely with a buyout transaction sealing its fate, is no longer ground-breaking news. The ‘demise of DB’ in the private sector, accelerated since the 2008 financial crisis, and the changes to public sector DB provision, subject to much debate and protest, have been so well documented that it’s been easy to miss another employment sector that has been battling with its pension liabilities: charities.

However, cracks in charities’ perseverance widened late last year. November 2012 saw People Can, a charity that supports communities and individuals that have experienced homelessness and domestic abuse, enter administration as a result of its £17 million pension deficit. This figure was a £6 million increase from earlier in the year as a result of its latest triennial valuation.

This year began with children’s charity Barnardo’s announcing that it was closing its career average staff pension scheme to future contributions by 31 March, citing the economic conditions increasing the volatility of the liabilities.

The scheme is one of the largest in the sector, with assets of over £464 million and liabilities of £548 million, a shortfall of £84 million.

Also, March saw the Institute of Cancer Research complete a buy-in deal for its pension scheme, covering £30 million of liabilities, with Pension Insurance Corporation in what was described as a “gilts-for-annuities trade”.

Therefore pension deficits are certainly an increasingly significant issue for the charity sector. According to a recent survey of the top 20 charities by income by Pensions Age’s sister title, Charity Times, only one scheme was in surplus, two were running DC only schemes and 17 recorded a combined deficit of £900 million.

These deficits have not just appeared in the last six months though. The pension schemes of charities are no different to any other pension scheme, and are facing the same challenges of market volatility, inflation and interest rate risk, and rising longevity.

So why are these issues rising to the surface now? According to PTL client director Melanie Cusack, there is often a ‘lag’ in receiving charity revenues compared to the private sector, sometimes up to 18 months, causing a delay in responding to the pension deficit.

“So while scheme closures may have been more prevalent in the private sector 18 months ago, they are increasingly appearing in the charity sector now.”

Another factor for the delay in tackling these problems is the paternalistic attitude of the third sector. As Premier head of consulting John Reeve explains, charities generally pay lower wages, so benefits such as pensions become more valuable to the employees.

Even deferred members may still help out the charity and volunteer, so it is important to still treat them well, unlike the private sector, where deferred members have often left to work for the competition.

Competition is another reason for charities’ reluctance to move away from DB schemes. As charities are often competing with the public sector, they need to be seen to provide similar benefits. The PR and reputational risk of changing staff pensions is also a consideration.

While there have been strong reasons for charities to cling onto DB provision, there have also been funding challenges unique to the sector which makes the situation even more difficult.

Unlike the private sector, charities do not have shareholders to turn to in order to plug the pension gap. Not only that but a proportion of the assets a charity has may be tied up in restricted funds, meaning that it can only be used for the objective it was donated for, not for operational costs. Charities may also lack other assets, such as property, which can be used as contingent assets for the pension scheme.

Also, this ‘age of austerity’ has hit charities comparatively harder. At a time where its services are being the most stretched, donations are cut back, as charity-giving is often the first thing to go for both companies and individuals.

Increasing longevity also leads to a shortfall in legacy donations. Charities tend to have a limited asset base as well, with the Charity Finance Group (CFG) reporting that a third of charities have no reserves.

Until recently, disclosing the pensions liabilities on the balance sheet for multi-employer schemes was down to the discretion of the company. As this made the FRS17 accounting rules inconsistent, there is a new accounting standard to be implemented under FRS102, due to come in from 2015, will require pension liabilities to be disclosed.

Spence & Partners director David Davison explains: “You can have an inconsistent current position identified by auditors where two charities in a local government pension scheme adopt a different approach with one disclosing and the other not. FRS102 will mean everyone will need to disclose. The result however could be that many charities will have negative balance sheets. If donors look closely and see that there is a big pension deficit in the accounts they may question donations or seek only to donate through restricted funds.”

Reeve agrees saying: “If you tell potential donors that 30p out of every pound they give will go towards the pension fund you will not get the money.”

Disclosure could also create difficulties for charities competing for outsourced public sector contracts, as they are reluctant to engage suppliers with a negative balance sheets, Davison adds.

While these challenges are considerable, those charities that manage their own pension schemes at least have some flexibility in how to manage their pension deficits. For the estimated 5,000 charities participating in a multi-employer pension scheme, their options are even more limited.

The benefits of entering a multi employer pension scheme are obvious, particularly for smaller sized charities, in terms of pooling assets and resources.

However, legislative issues are creating a ‘catch 22’ situation where charities are unable to afford to stay or leave the multi employer pension schemes.

Section 75 debt regulations apply where a charity in a multi employer pension scheme seeks to exit the scheme. The liability on this basis is much higher than on either an accounting basis or a funding basis and frequently means that charities are forced to continue building unaffordable liabilities as they are unable to meet the exit debt payment.

Multi-employer pension schemes also create a ‘last man standing’ risk, whereby if one company becomes insolvent and is unable to pay its pension debt, the cost is spread over all the other participants in the scheme. According to Davison, this ‘orphan debt’ in some schemes can account for up to 20 per cent of a scheme’s liabilities.

So, schemes struggle to leave the scheme, but face rising contributions. For instance The Pensions Trust (TPT), with 2,500 participating companies, has told employers in its scheme that their contributions will rise by 50 per cent from April 2013 and then by 3 per cent per year over the next 10 years, following a recent valuation.

TPT head of customer relations Logan Anderson notes that some charities have tried to build up reserves to deal with extra pension costs but have been forced to spend the reserves or risk getting their income cut.

So, as the CFG says: “The toxic mix of rising contributions and extortionate cessation debts create a situation that is simply unsustainable.”

This in turn can affect the overall running of the charity. High exit costs for the pension scheme can be a barrier for those looking to merge, as companies may be unwilling to pay that debt or retain the existing scheme and face unknown future liabilities.

In March Charity Times reported that the proposed merger between NAVCA and Community Matters could not proceed due to their pension deficits.

Both bodies had rising pension debt on withdrawal from TPT and after a detailed appraisal of the situation, both felt unable to pursue a merger for fear that a merged organisation would be hindered by pension deficits that had the potential to escalate.

Commenting at the time, NAVCA chief executive Joe Irvin said: “We have worked hard at these discussions and our trustees saw real benefits in bringing our members together for the benefit of local communities. But though we had overcome most of the obstacles that often prevent merger, we were scuppered by concerns about the rising pension debt. This is an escalating problem throughout the sector and something must be done about it.”

Indeed, there are efforts to ‘get something done about it’. The CFG is currently lobbying the government to permit charities to cease accruing benefits without automatically triggering a cessation liability. It is also calling for the possibility of a support fund to enable charities to pay off their pension deficits and pay the borrowed money back over an agreed period of time. It is also requesting more flexibility around the Pensions Protection Fund.

The pension schemes themselves are trying to de-risk as best they can through buyouts and buy-ins where possible, and adapting their investment strategies.

Cusack has found that while charities were not so receptive in the past, there is now increased interest in buyins. There is also a move away from investing in just equities and bonds and generating longer recovery periods, “all the things the private sector have been doing. Charities have been catching up a bit”.

A few years ago, socially responsible investment (SRI) was the ‘catchphrase’ of charities, “but now they are finding it hard to justify sacrificing investment return for SRI”, she adds.

Commenting on TPT’s investment strategy, Anderson says that there is a focus on LDI to protect on the liability side and a need for diversification on the growth side. The investment pots are split between equities and alternatives and within that liquid assets, such as emerging market debt, or distressed debt, and illiquid assets such as infrastructure, he explains.

It may have been occurring later than in the private sector, but charities have been increasingly moving away from DB and towards DC schemes, a process accelerated by the emergence of auto-enrolment.

Davison says: “A lot of charities could also face significant auto-enrolment issues as they may only have 30-50 per cent of their staff in a DB pension scheme and would struggle to afford placing all employees in such a scheme, instead looking to open DC schemes to meet their auto-enrolment obligations.”

He adds that while there is a desire to move to DC, “the difficulty is with many multi-employer pension schemes not having a DC offering available”. This has started to change in the last 18 months, for instance with TPT launching its DC platform, SmarterPensions, in September last year.

CFG head of policy and public affairs Jane Tully adds that auto-enrolment also creates extra challenges for charities, as they tend to have a huge number of part time staff and seasonal workers, adding to the complexity of complying with the regulation.

However, charities are trying to ease the pension burden in whatever ways they can. Cusack notes that charities “put the private sector to shame” in their ability to get value for money for everything, from lawyers to actuaries, administrators and investment advisers. However, she adds that the charity sector could look to the private sector for ways to manage conflicts of interest in the governance of pension schemes, she adds, citing the “blurred conflict” when charity trustees are also pension scheme trustees.

The third sector may be following suit with the private sector in its struggle to manage pension deficits, but until the additional barriers preventing charities from effectively tackling this issue are addressed the stories of scheme closures and insolvency due to spiralling pension costs look set to continue.

Laura Blows is the editor of Pensions Age

Share Story: