Trustees of charity defined benefit pension funds face several challenges specific to the not-for-profit sector. With their sponsors under increased financial pressure, what does this mean for their DB arrangements?
The decision is not unique to the charity sector. Most UK employers – whether they are charities, not-for-profit organisations or corporations – are taking steps to reduce the volatility and risk of their DB arrangements.
If there was a commercial provider that allowed entry, but payments over a set period… that would be very attractive to a charity
Rob Dales, JLT Employee Benefits
Research by consultancy Hymans Robertson, published in May, found that 58 per cent of charities have closed their DB schemes to future accrual, based on the largest 40 charities by income in England and Wales.
Charities under pressure
While charities are moving in line with their corporate counterparts when it comes to the decline of DB, they face several challenges specific to their sector.
Many charities are under increased financial pressure. A Charities Aid Foundation survey in 2017 found that 18 per cent of charity chief executives agree that their charity is struggling to survive. This rose to 28 per cent for smaller charities.
In 2018 Charity Financials found that total income to the top 100 fundraisers in the UK grew by just 0.7 per cent in real terms between 2015-16 and 2016-17.
What does this mean for these charitable organisations’ DB pension arrangements?
Contingent assets crucial
Although fundraising difficulties may be putting pressure on income for charities, the key metric for pension trustees is the level of reserves, according to Alistair Russell-Smith, partner at Hymans Robertson.
He notes that quite often charities have strong balance sheets and reasonable levels of reserves, meaning schemes have assets they can call on.
“As long as charities are protecting their reserves position, I think pension scheme trustees can still take a longer-term view,” Russell-Smith says.
Contingency planning is particularly important in this sector, he adds. Where charities may be cash poor but asset rich, those assets may give the pension scheme more security.
Ruth Bamforth, director at law firm Walker Morris, echoes this view. “It’s important… in terms of covenant, to understand how the charity is structured and what may actually be available, and that then partly goes to affordability and also whether or not you could put any form of contingent asset in place,” she says.
Kate Freeman, senior associate in the charities pensions group at law firm CMS, says: “Employers in the charity sector are of course often balancing a desire to ensure they are ‘good’ employers and so offer good pension provision, with the need to show that the charity spends every penny it has wisely.”
This plays into the decisions employers make regarding future pension provision and management of existing liabilities, as well as funding negotiations with trustees, she says.
The Pensions Regulator has said the fact that not-for-profit organisations do not aim to generate returns to shareholders “does not itself change how their covenant should be assessed”, according to the watchdog. However, it acknowledges that the nature of some organisations’ activities and financing arrangements means some of the factors in the regulator’s covenant guidance may apply differently, or that additional factors will need to be considered.
David Davison, director and owner of Spence & Partners, says that if charities get income from third parties or local authorities through outsourced contract work, it will be to do a certain job. “There’s very little flexibility usually in that income for pension provision, for example”, he explains.
Do we need a commercial consolidator for charities?
Pension schemes sponsored by charities are assessed differently for Pension Protection Fund levy purposes, “so schemes need to ensure that the credit rating used for the PPF reflects the charity’s true financial standing”, notes CMS’s Freeman.
Dinesh Visavadia, director at Independent Trustee Services, who also has experience as a charity trustee, says it is worth starting a debate as to “whether there is a merit in forming a consolidated fund specifically for the non-profit sector”.
If a charity runs into difficulties, it can wind down its contracts and another organisation can take over those contracts, but “there’s a big question about whether they’d be prepared to also take over the pension liabilities”, he says.
“Not-for-profit organisations probably require a slightly different approach... if the charity were unable to carry on its business, then can they wind down or can they transfer the pension liabilities to the PPF and let some other charity run the contracts?.”
He says the “best of both worlds” would be that the charity’s services will still continue, but under a different umbrella, without the baggage of the pension liabilities.
“For the schemes who can’t actually offload into the PPF because… they have to pass on the business to another charity,” there should be an ability to go either to the PPF or “to another consolidator fund in the middle”, he says.
The latter option could work in a similar way to the vehicles that have been established so far this year, such as Clara Pensions or the Pensions Super Fund, according to Visavadia.
Rob Dales, head of corporate consulting at JLT Employee Benefits, says that something like the Clara model could work well for charities, “but you still need a commercial organisation to put the capital behind it and the charities still need to pay the cost of entry”.
Finding significant cash to pay that cost to enter would be difficult for a charity, he says.
CAF exits multi-employer scheme to set up own fund
The Charities Aid Foundation has withdrawn from a multi-employer defined benefit pension plan and established a new DB scheme, removing its exposure to other employers’ pension liabilities.
“Perhaps if there was a commercial provider that allowed entry, but payments over a set period… that would be very attractive to a charity,” Dales notes.
However, from a trustee perspective it is not as clear cut, “because you’re swapping the covenant of the charity for the covenant of an unknown commercial provider”.
Davison is not convinced. “I don’t really think that you would look at a £100m scheme with one of the large charities in any different way than you’d look at a £100m scheme with a private entity”, he notes.
TPT Retirement Solutions, a DB master trust offering multi-employer and standalone workplace pension schemes, already exists as a consolidation option. Each scheme has its own separate section in the trust to ring-fence assets and liabilities. Many charities participate in multi-employer schemes.
In April, the government introduced the deferred debt arrangement.
The DDA gives employers that belong to multi-employer schemes more flexibility to cease accrual without triggering an immediate section 75 debt.
“This is a potentially attractive tool for charity employers [that] belong to multi-employer schemes and who are concerned with the cost and volatility of continuing ongoing accrual,” says CMS’s Freeman.
