A perfect storm of plunging yields on government gilts, more people living longer and expensive final-salary schemes has created significant pension deficits for many charities. There have even been warnings that some charities could become technically insolvent because of their deficits.
The new financial reporting standard, FRS 102, which takes effect at the start of 2015, means that charities in multi-employer pension schemes will have to show pension liabilities on their balance sheets. Many smaller charities might become insolvent and face the possibility of closure, according to Chris Harris, a partner at the accountancy firm MHA MacIntyre Hudson.
The general outlook for pension schemes across the board has become worse in the past 12 to 18 months as a result of increased longevity, poor equity returns and the government's quantitative easing, which has led to falling returns on government gilts.
This affects both charities with their own final-salary pension schemes and those in so-called multi-employer pension schemes. These schemes include many employers; examples include those run by the Pensions Trust and local authority-managed schemes that charities have joined. Many charities that took on the delivery of public services found themselves having to take on the responsibility for generous final-salary pensions schemes enjoyed by local authority staff.
One of the problems with multi-employer schemes is that it can be very expensive for a charity to leave the scheme when a deficit occurs. And when an employer does leave a multi-employer scheme or the scheme closes, its liabilities become "orphan liabilities", which the other employers in the scheme must then underwrite.
Alistair Russell-Smith, senior consultant for actuaries at the pension consultancy Hymans Robertson, says that although the level of orphan liabilities seems manageable now, it can only get worse over time because of the nature of defined-benefit schemes.
So what can charities do in the face of these problems? Guy Mander, a partner at the accountancy firm Baker Tilly, says charities that sponsor their own schemes will need to agree recovery plans if they are in deficit. This shows the level of contributions an employer will need to pay over a period of time to clear the debt.
"The Pensions Regulator has indicated that contributions should be reasonably affordable and aligned with the sustainable growth of the employer," says Mander.
Where there is a deficit, he says, a charity might need to offer assurances that the pension benefits will be protected. For example, a charity might say that, in order to protect the interests of its members, a pension scheme would have a claim against charity assets such as property.
Seek professional advice
Harris says that the complexities of pensions can make it difficult to provide general guidance on what charities with deficits should do. "I would strongly advise any affected charity to seek professional advice," he says.
There are, however, a number of options for charities facing such problems, including transferring out of a multi-employer scheme through a "bulk transfer", says Russell-Smith. A charity can also close its defined-benefit scheme to future accruals, which is a way of "turning the tap off" - many of the largest charities have taken this step already, he says.
"Charities might need to come up with a plan that enables them to pay off their deficit over 20 or 30 years with less risky investments," says Russell-Smith. "Better to do that than try to pay it off more quickly with riskier investments."
CASE STUDY - PSS AND ITS PENSIONS STRATEGY
The Liverpool-based health and social care charity PSS is facing a pension deficit of more than £2m, relating to one of the Pensions Trust's former growth plans.
When PSS, which has an income of nearly £15m, joined the scheme in the 1990s, it was marketed as a defined-contribution scheme, according to Lesley Dixon, its chief executive. But because it guaranteed a minimum level of payment, it was affected by a legal ruling in 2011 that found such schemes should be regarded as defined-benefit.
"It can be tempting to panic in that situation, but it's important to take a measured approach," says Dixon. About 220 current or former PSS employees are members of the growth plan. Staff joining a pension scheme now have to join a defined-contribution one, she says.
PSS has been working with a pensions adviser to develop a strategy to pay off the deficit because it does not have sufficient skills in-house to handle the challenge.
The core of the charity's recovery strategy is to increase employer pension contributions by about £130,000 a year over the next 10 years.
"We are funding this pension increase through efficiencies in the organisation," says Dixon. She says the charity will be monitoring its progress regularly.