When working with charities on their pension provision I’m constantly reminded of the old joke about the man stopping and asking for directions in Ireland and being told “Well sur, if you’re trying to get there I wouldn’t be wanting to start from here!” This feeling of being a bit lost and not quite sure where to turn is an all too consistent theme.
So in terms of developing a suitable strategy for the future what should charity trustees be looking at?
Understand your existing arrangements
When starting with a blank sheet of paper and planning a future pension strategy the position is usually much clearer. However for most organisations there is a legacy to deal with. Many charities competed for staff with the Public Sector and there was historically a drive to provide pensions similar to those in the public sector or where taking on outsourced public sector work there was a requirement to provide broadly comparable pension schemes. Charities therefore tend to participate in defined benefit arrangements such as Local Government Pension Schemes or multi-employer schemes (such as those run by the Pensions Trust, ITB, Federated Flexiplan etc). Some larger organisations may well have established their own defined benefit scheme and/or be running defined contribution arrangements.
Pension schemes have become much more expensive to offer – higher administration costs, lower investment returns, low inflation and increasing longevity are the main contributors and increasing deficits have put a strain on resources.
Most multi-employer schemes are written on a ‘last man standing’ basis which means that should any organisation fail its shortfall would be distributed amongst the other participants. A large failure could have potentially catastrophic implications for some smaller charities.
Understand the exit position
Defined benefit pension schemes are funded on the basis that they continue indefinitely with the cost of benefits paid over the working lifetime of the scheme member. The position should an organisation wish to exit the scheme is significantly different as the costs of securing the benefits at that point will be considerable higher and frequently well in excess of the net asset value of the charity.
Many charities are therefore faced with Hobson’s choice in relation to their scheme – namely dealing with continually rising annual contributions or an unaffordable exit cost.
In addition the way pensions legislation is currently framed for these multi-employer schemes means that should an organisation run out of ‘active’ members the debt will trigger regardless of its affordability, threatening the very existence of the charity and further impacting on the ‘last man standing debt’ within the scheme.
Understand the contractual position
Organisations need to understand what promises have been made to staff and the risk that these place on the charity. These might not only be risks from within the pension scheme but also where contractual benefit promises have been made, particularly to senior employees.
Organisations also need to understand that when providing benefits through a local government scheme they could be assuming responsibility for liabilities and costs related to an individual’s prior period of service and these can be very significant. I’ve seen examples where legacy liabilities prior to the formation of a charity accounted for 80% of the total and where charities incurred hundreds of thousands of pounds of ‘strain costs’ for employees with only very limited service with the charity.
Understand your accounting position
Pension liabilities are now much more transparent – accounting standard FRS17 has meant that charities running their own schemes need to disclose their liabilities. Most participants in LGPS will also disclose and LGPS administrators have streamlined processes for providing these figures. Other multi-employer schemes may or may not disclose depending on circumstances. If they don’t disclose then organisations need to be aware of the impact should this position change.
Charities also need to be aware of the impact their disclosures may have on their finances. Donors may have a concern that too much of their money is going to staff pensions and not to support their charitable objectives. Local government sponsors may prefer to fund organisations without defined benefit pension liabilities as more money goes directly to the service. Service suppliers may require financial security to provide services.
The accounting disclosure assumptions are the responsibility of the charity trustees and they should be adopting a basis which reflects their individual circumstances – so don’t just accept the status quo provided by the LGPS.
Beware of change
Pension schemes can frequently be a major obstacle, if not the most significant barrier, to a financial re-structure such as a merger or incorporation as the change of status of an organisation can trigger the exit debt. Charities should not look to re-structure without having sought professional advice about their pension at a very early stage.
Prepare for auto-enrolment
New legislation will require organisations at a point between 2012 and 2016 to automatically enrol staff in a pension scheme and pay contributions on their behalf. The administrative and financial implications of this new legislation could be significant and the impact highly dependent upon the current pension position organisations find themselves in.
Organisations without a pension scheme will see themselves having to establish one whilst those with existing arrangements will need to consider how best to incorporate any necessary changes. Should organisations already have a defined benefit pension scheme, but with a low staff take up, they could see a significant increase in costs and associated risks. Those with multiple schemes could find implementation complex.
Get a strategy
Ultimately organisations need a strategy for their future pension provision which meets their human resources requirements, provides attractive benefits for staff and is affordable both now and in the future. The strategy may not deliver an ‘instant fix’ but may need to be run over a period of time to arrive at a suitable long term solution.
There are undoubtedly solutions to the problems organisations face but the issues need to be addressed head on.