October 14, 2013

Defined benefit pension schemes: the millstone weighing down charities?

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Charity law and governing documents stipulate that only unrestricted or designated funds can be used to reduce a pensions deficit, writes Terry Saeedi.

Charities and their defined benefit pension issues continue to make headline news.  The Royal Geographical Society has sold part of its collection to fund its pension deficit.  Pension scheme liabilities scuppered the Navca and Community Matters merger.

A significant number of charities sponsor defined benefit pension schemes for employees.  However, the combination of increased longevity, increased regulation and the economic downturn have led to significant scheme funding deficits. Many affected charities have been put under severe financial pressure or, in some cases, wound-up.

Charities also face other pensions challenges.  A debt arises when a charity winds-up its scheme or ceases to have any active members in a multi-employer scheme.  This debt is calculated on the buy-out basis – the cost of securing liabilities with an insurance company.  The buy-out pension cost for the top 50 UK charities is £4.7bn (Charity Finance Group figures).

One of the main issues for charities in dealing with defined benefit pension scheme funding issues is that charity law and the charity’s own governing documents restrict how charitable funds can be used.  Charity trustees have a duty to act in their charity’s best interests and to safeguard their charity’s assets, ensuring that those assets are used for the charitable purposes.

Charities hold various funds. Unrestricted funds can be used for the charity’s general charitable purposes.  Restricted funds can only be used for the specific purposes for which they are given: those restrictions cannot be lifted without the donor’s agreement. Designated funds are used for certain purposes designated by the trustees: such funds can be undesignated by the trustees.  The capital of permanent endowment funds cannot generally be applied, only the income accruing to the capital.

The above highlights the fact that, unlike a private company, a charity is not free to deal with its assets. Only unrestricted or designated funds may be used to reduce a pensions deficit – but is that how the public want their donations used?

The economic climate has also presented charities with challenges. Investment returns are down, donations have reduced, costs have increased and grant-giving bodies have less money to distribute. Equally, grant funding may be lost if funders believe too much of their grant will be directed towards reducing the pension deficit.

Many charities with their own defined benefit pension schemes have already closed them to new members and future accruals. This will not remove ongoing funding issues – the liabilities will continue to be affected by longevity and investment return.

One option is to provide contingent assets, the value of which are available to the scheme on specified events, such as employer insolvency. Contingent assets include charges over property, letters of credit or parent company guarantees. Only the largest charities are likely to be able to put provide contingent assets in place.

Many charities participate in multi-employer schemes. An exit debt in such a scheme can be avoided where pension accrual stops simultaneously for all employers, but getting the agreement of many unconnected employers is difficult.  Even when accrual has stopped, a charity is required to continue to fund the scheme and a share of the orphan liabilities relating to charities which have already ceased to participate.   This leads to other charity law issues: a charity is only able to give a guarantee if it furthers its charitable purposes and it has an express power to do so. It is unlikely that it would be entitled to guarantee the liabilities of an unconnected charity.

The government has established a working group to consider the pensions issues which charities face.  The conclusions of this group are eagerly awaited.

Terry Saeedi is a partner and head of pensions.