Analysis: How pensions halt mergers and create zombie charities

Many charities with pension deficits are not aware how dangerous their position has become over the years

Pensions: the cost of schemes for staff in their old age can cripple charities
Pensions: the cost of schemes for staff in their old age can cripple charities

The local infrastructure bodies Navca and Community Matters announced last week that they would not go ahead with a planned merger because they were worried about "pension deficits with the potential to escalate".

These two organisations are far from alone in abandoning a merger because of worries about another organisation's pensions debts, according to Jane Tully, head of policy at the Charity Finance Group. Many other charities, she says, have experienced the same problems.

"Many charity finance directors say that pensions are the problem that keeps them up at night," she says.

The several thousand charities in multi-employer defined-benefit pension schemes face the biggest problems, she says. These include local authority schemes, which charities must often join when taking on council staff as part of a contract; schemes run by a national charity with independent local affiliates, such as YMCAs and Age UKs; and several Pensions Trust schemes, including the Growth Plan, of which both Navca and Community Matters were part.

Limiting liabilities

For employers that have their own schemes, it can be possible to limit pensions liabilities by closing a scheme to future accruals. But organisations in a multi-employer scheme usually do not have this option.

These schemes are extremely difficult to leave. Typically, when a charity's final employee leaves the scheme, the charity faces a 'cessation liability', meaning it must make up its entire deficit immediately. A charity's deficit on this 'withdrawal basis' is based on a different, stricter set of assumptions. So the bill for leaving is much higher than if the charity remains in the scheme, and is usually unaffordable for most charities.

A charity planning a merger might find that the move would trigger a cessation liability - either because the current charity itself ceases to exist or because its employees in the scheme are at risk of redundancy.

There are rules and structures that allow charities to merge without triggering an exit debt, but a bigger barrier might be the size of the debt itself. If one party to a merger has built up significant debts, the other might not want to take on exposure to its partner's liabilities.

Full pensions information is provided to trustees only triennially by pensions providers, and is not always studied in detail. So sometimes it is only during the due-diligence process of a merger that the full extent of a charity's pension liability becomes clear, even to the trustee board of the organisation carrying the liability.

Pensions deficits can cause more serious problems than failed mergers, however. A recent letter from Navca, the National Council for Voluntary Organisations and the Charity Finance Group to the pensions minister Steve Webb said that many charities now faced a real risk of closure, while many others were forced to divert donations from their causes to fund growing pensions debts.

The letter to Webb asked for changes in Department for Work and Pensions rules to address these problems - in particular, to allow charities to leave multi-employer schemes without having to pay off their deficits immediately, and to develop a support fund "to allow charities to borrow money to pay off their pension deficits and then pay the borrowed money back over an agreed period of time".

Multi-employer pensions schemes

Alastair Massey, a director at the insolvency specialist FRP Advisory, says that under existing rules many organisations in multi-employer pensions schemes can continue to exist for many years, but will eventually have to close because of pensions debts. Such organisations, he says, are known as "zombie charities" because they are "effectively the walking dead".

"There are many organisations whose debts are so severe that they will never, in the ordinary run of things, be able to repay them," he says. "Funders who look at their books will be reluctant to provide grants because they know their money will be spent on paying for pensions. Their pension liabilities are great anchors, gradually slowing them down, until eventually they are dragged under."

Gill Taylor, a sector HR consultant who has been a trustee for a charity that wanted to merge, says many charities with defined-benefit pensions deficits might continue to exist only because they do not realise the true scale of their problems. She says that when trustees contemplate a merger or other change they might examine their balance sheets in detail and "find they need to make a different set of decisions" about the viability of their organisations.

In this situation, she says, even though nothing has changed except the information available to the board, the charity might feel it needs to look at whether it can continue as a going concern.

"You suddenly become aware that you have a pressing duty to your creditors, as well as to your beneficiaries," she says. "It's scary. You become worried about negligence and personal liability."

Her advice to trustees is that they should try to act well before this point. "People can be word-blind about pensions," she says. "You might not understand it. But it's best to have a good idea about your own liabilities, and to make sure that pensions are on your list of non-negotiables when you go into a merger."

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