A perfect storm - defined benefit pension scheme

The Issue

The confluence of pressures currently faced by charities is well documented. These include:

  • downward pressure on donation and legacy income - reduction in donor disposable income, increased donor apathy, increasing competition for donor support and instances of adverse press coverage in the sector;
  • increased fundraising costs to secure donor favour; and
  • operating deficits being experienced by charities providing funded services to the public sector – reduced annual funded income for same service provision due to austerity or budgetary constraints and increased operational costs, leading to ever more reliance on non-funded income.

To add to these pressures, charities who support DB pension schemes are facing a further significant challenge, one which of itself or when added to other pressures, is in some instances calling their (long term) viability into question.

The Added Burden

The economic environment over recent years has conspired against many sponsors of DB pension schemes, with low gilt yields driving up the level of pension scheme liabilities (and deficits).

So, despite the best efforts of many sponsors to fund their deficits, many have found themselves effectively ‘going backwards’ between triennial actuarial valuations; this without any appreciable change in their financial position (or covenant strength) and ability to support the scheme.

The primary challenge faced by DB scheme trustees is to meet members’ benefits, in particular addressing the funding deficit in a timely manner. This is increasingly difficult (and arguably frustrating) for the charity at a time when the deficit may have increased for reasons outside of the charity’s control and given the backdrop of the various and competing pressures it faces.

The competing demand on resources adds weight to the charity’s need to balance the interests of its various stakeholders. Often the scale of the deficit relative to a charity’s resources means that the scheme is typically a major stakeholder.

The concern often expressed is the conflict between the charity’s obligation to its scheme and the resulting draw on funds that would otherwise be used for meeting charitable purposes or objectives.

In addition to the financial aspects associated with sponsoring a DB scheme, administration of the scheme can also be a major call on management time; in many cases management may have both sponsor and scheme trustee roles; the latter is not necessarily without risk of personal liability.

Common Issues, Different Challenges

Whilst the issues above are not unique to the charity sector, there are a number of additional challenges which are specific to charity sponsors, above and beyond simply the utilisation of funds for non-charitable purposes.

These additional challenges include:

  • the potential negative impact on donor attitude and appetite when a (substantial) proportion of the charity’s resources are being deployed to address the scheme deficit;
  • the additional limitations on scheme funding and restructuring options due to the existence of restricted funds (funds donated for a specific purpose); and
  • potential limitations on a charity’s ability to grant security to the scheme or to support borrowings.

The last of these, together with general lender reticence, can also limit a charity’s ability to secure borrowings to support any restructuring.

In addition to the potential involvement of the Pensions Regulator (tPR), further regulatory focus is provided by the Charity Commission and sector relevant bodies such as the Care Quality Commission. Compliance with regulatory requirements are one of the primary matters of focus for a charity’s management on a day to day basis.

Where viability is in question (or may come into question) and a scheme is funded below Pension Protection Fund (PPF) levels, both tPR and the PPF would become involved in looking at the financial position of the charity and its restructuring options (if any).

Unlike ‘corporate world’, the ability to structure solutions such as a regulated apportionment arrangement for a scheme with a charity sponsor is restricted given the inability:

  • to provide an equity stake; and/or
  • to provide an acceptable level of return to PPF above insolvency realisations in return for compromising scheme liabilities.

Finally, the vulnerable nature of many charities’ clients can present an additional challenge in any restructuring scenario.

Meeting the Challenge

The trend of increasing scheme deficits in recent times makes a proactive approach to dealing with the challenges posed essential. The significant number of underfunded DB pension schemes sponsored by charities, means that considerable support is available.

We recommend utilising professional support in the first instance, be it covenant, legal, actuarial or a combination. It is crucial to understand the extent of the charity’s obligations, the current funding position of the scheme, the charity’s ability to support the scheme, the potential risks involved and how to best monitor the situation.

A collaborative approach between charity trustees/management and pension scheme trustees will be at the core of any successful resolution.

RSM has a specialist dedicated covenant advisory team and we would be delighted to discuss these issues with you.

Please contact Karen Spears or Guy Jackson for more information.