DB Pensions: the next charity crisis?
April 16, 2018
In 2017 charities were on the hook for over £7 billion in defined benefit (DB) pension liabilities – this could well be higher now - how can your scheme be managed? And do you understand your covenant?
A report by Hymans Robertson in 2017 quoted that the top 40 charities in England and Wales had pension liabilities totalling £7 billion. This figure is set to increase as many pension schemes are undergoing their triennial actuarial valuation processes. A combination of the number of employees still building up retirement benefits, life expectancy increasing, and persistently low gilt yields means the outcome of many of these valuations will be a growing deficit.
At a time when pension deficits are at an all-time high, scrutiny is increasing and with several high profile schemes in the spotlight it is important as a charity that directors and both charity and pension trustees are protecting the scheme’s members.
Charities and pension trustees are facing an increasingly difficult task in balancing their obligations to their beneficiaries compared to their former employees. As a pension trustee or a charity trustee, you should be asking yourself what this means for your scheme and its strategy.
So how can you ensure you manage your pension scheme properly?
Step 1 - Understand your covenant:
The pension regulator states that ‘the employer covenant – the employer’s legal obligations to a defined benefit scheme, and its ability to meet them – remains a crucial element in protecting members’ benefits’.
The regulator has also made it clear that pension trustees have a duty to keep the employer covenant under constant review, and not merely address this at each triennial valuation.
So what should you be doing?
Step 2 – Ask for financial information:
That means pension trustees must ask for regular financial information about the charity and make sure that they understand it. If charities want pension trustees to form an accurate understanding of the covenant it is essential they provide information which is current and easy to understand.
What do you do with this information?
Step 3 – Identify the strength of your covenant
A charity is unlike its commercial equivalents and therefore reviewing a charity has an added layer of complexity. At PwC, we think there are six main areas to reviewing your covenant:
The first is looking at the pension scheme’s access to value from the charity i.e. are there other group entities that can lend support?
The second is the employer’s balance sheet and financial risk i.e. how much financial flexibility is there? And what is the charity’s reserves policy?
The third is the employer’s current and future surplus or deficit and cash flows. A charity must look at how much of its income is restricted or unrestricted. It must also understand its reliance on limited sources of income such as voluntary donations and the proportion of income which comes from the government.
The fourth is a top priority in assessing covenant for the pensions regulator - the sustainable affordability of pension contributions.
The fifth is the market/policy context in which the employer operates.
And lastly the exit covenant, which shows how the scheme fares in a downside insolvency scenario.
It is important to remember that charities are not-for-profit organisations, so it is even more important to understand a charity’s short, medium and long term flexibility in terms of cash flow and profitability.
- Recognise the commercial difference of a charity but understand that the charity still needs to be treated commercially
- Recognise the core strength of the charity and make informed decisions on the basis of this
- Be proactive not reactive - consider how your scheme would be viewed if under external scrutiny tomorrow
Further to the above we will soon be posting articles focussing on integrated risk management and sustainable affordability for charities.