Salvation Army derisks as charities struggle with pension deficits

Rising deficits have proved problematic for most corporate pension funds over recent years, but the issue can be more complex for charities with DB schemes, as some struggle to balance closing the gap between assets and obligations with using donations towards their charitable goals.

Generally, the tolerance for underperformance in pension assets is lower in a charity scheme, as a drain on charity finances to pay staff pensions could be a political minefield

David Hickey, SEI

The trustees take “a fairly simplistic approach” to the scheme deficit situation, said Steve Hammer, pension funds manager of international Christian charity the Salvation Army.

The fund closed to members four years ago, a move that has become increasingly common not only in the private sector but also among charities faced with pressures on the liabilities of their DB pension funds.

More recently, Hammer said the scheme’s investment allocation has been altered. “[We] moved some [money] out of equities and into bonds” to match liabilities and reduce risk, he said.

Previously, the fund had about 75 per cent of its assets invested in equities and 25 per cent in bonds. However, this allocation has now been changed to around 65 per cent equities and 35 per cent bonds.

The fund’s latest triennial valuation was carried out in 2015 and revealed a deficit of “about 4 per cent” and “the employers agreed to pay special contributions”, said Hammer.

Although the deficit was “better than it was” following the previous valuation, he said it may have increased again due to recent market conditions.

Dealing with the deficit

In recent years yields have continued to fall. Alex Koriath, head of Cambridge Associates' European pensions practice said the difficulty for a lot of schemes at the moment is deciding “how to close this deficit in an environment where, frankly, a lot of your growth assets don’t look cheap”.

“So you have this challenge... your deficit is high, interest rates have fallen quite a bit, you’re probably underhedged… what do you do from now?”

Koriath said that a scheme has to decide how to structure its portfolio “so that it still gets you a certain expected return, which many schemes need to close the deficit, but also make it more robust on the downside” by looking at other asset classes for true diversification.

However, the majority of charity pension schemes are small and may not be able to easily access more complex investments.

David Hickey, managing director at fiduciary manager SEI’s EMEA institutional group, said: “Generally, the tolerance for underperformance in pension assets is lower in a charity scheme, as a drain on charity finances to pay staff pensions could be a political minefield.”

Hickey noted that many charity schemes adopt a very low risk appetite, leading them to extensive reduction in liability risk and a low tolerance for more exotic and complex alternatives “that could also come at high fees”. 

Clear communication is key

Anjelica Finnegan, senior policy and public affairs officer at the Charity Finance Group, which aims to support finance professionals in the sector, said there are a number of unique challenges for charities with regard to their DB pension funds.

If a charity has a high pension deficit, this “might impact the charity’s funding situation”, she said.

Moreover, Finnegan noted that some charities, particularly smaller ones, have entered into multi-employer pension schemes to share risk. However, section 75 debt regulations require these charities to pay a large lump sum when they want to leave a scheme, which they are often not able to afford.

Clear communication of plans to close the pension deficit is important, as charities can be scrutinised for putting funding money towards pension obligations rather than charitable activities.

Finnegan said that “one of the things I’d really recommend… is sitting down with the board of trustees, the finance team and senior management” and talking through how a charity can clearly explain to the public, in the annual report, what the plan is in terms of managing its pension obligations.

Many charities' annual reports these days are already “incredibly detailed”, including about how money is spent, she said.

“Charities are facing the problems that all other employers are facing in terms of DB schemes,” said Finnegan. But she said it was important to highlight the fact that  “charities need to offer their employees good benefits”, in addition to carrying out their charitable duties.