The essentials Pensions: Five ways to fix your deficit

No sentence containing the word 'pensions' is complete these days without the less wonderful word 'deficit', and charities have been as hard hit as any other type of organisation. Joe Lepper outlines five steps to closing the gap.

Pension deficits have become a key concern for charity finance directors over the past decade. An ageing population, declining birth rates and poorly performing investments have left many charities with holes in their pension funds.

Some have already taken firm action to address the problem, most notably by closing their final-salary schemes to new members.

But some will need other measures, including increased contributions, additional lump sums or raising the age of retirement. As if this wasn't enough to deal with, charities are also seeing a period of unprecedented change in pension law.

For example, tougher staff consultation rules for altering pensions came in this month, there will be new legislation to allow staff to draw pensions and stay on as employees, and new age discrimination legislation will effectively axe the maximum retirement age.

More reform could result from last year's Turner Commission report into the future of pension provision. This recommended a radical package of measures, including a national pensions saving scheme and a later retirement age.

Finance directors are also having to keep a close eye on the Pension Protection Fund, set up to ensure that staff of schemes that go bust still get a pension, because it is seeking a levy from charities as well.

Penny Kogher, head of pensions at legal firm Speechly Bircham, says this is one of the toughest times yet for those running pension schemes. "It's very difficult to keep on top of all the new legislation while ensuring your scheme is affordable and offers the kind of benefits that are attractive for recruitment purposes," she says.

Whether you are concerned about your pensions deficit or are experiencing other problems with your scheme, this step-by-step guide will help you on your way.

1. CONSIDER CLOSING YOUR FINAL-SALARY SCHEME TO NEW MEMBERS - Understanding why your deficit has arisen is vital to helping you decide what action to take. A key reason for most charities is that their final-salary schemes have been hit hard by a combination of a poorly performing investments in the City and medical advances that increase longevity.

This has left many charities facing a tough choice between closing their schemes to new members or weathering the storm and keeping them open.

The latest figures from the Charity Finance Directors' Group in its 2004 report The Pensions Maze showed that closure has become increasingly popular.

Of 115 charities surveyed, six out of ten did not offer final-salary schemes and 21 charities closed their schemes to new members between 2001 and 2003.

One of those was the British Heart Foundation, which closed its final-salary scheme to new members in 2001 to tackle its deficit, which was £6m in March last year. "Our advice was that this was a sensible course of action," says Suzan Willing, benefits officer at the BHF.

Closure will not be the best course of action for everyone, of course.

It can restrict a charity's ability to compete in the recruitment market, says Stephen Nichols, deputy chief executive of the Pensions Trust; it can also make the situation worse, because having fewer members means less money going into the fund.

He says that some charities with closed schemes are now having second thoughts and are even considering reopening them to boost membership and contributions.

"No one has actually done it yet, and it would be a brave move - but there are some that are considering it," he says. "I think what is happening is that everyone is waiting for the first one to appear before they make their move."

2. CONSIDER RAISING CONTRIBUTIONS - Whether charities are closing their final-salary schemes or not, another common method for reducing deficits is to raise contributions from employees.

The RNID, which closed its final-salary scheme in October 2001 and had a deficit of £9.6m in March last year, is one of the many organisations to have done this. From April 2004 it decided to raise employee contributions from 5 to 6 per cent and increase its own contributions from 15.8 per cent to 18.7 per cent.

Kogher of Speechly Bircham says it is vital to liaise with staff because a change in contribution level can mean a change in terms and conditions.

"Because they are ethical employers, the likelihood is that charities are probably already doing that," she says.

She adds that changes coming into effect this month through the 2004 Pensions Act, which put a greater emphasis on consultation with staff over pension changes, will also ensure charities are not left open to potential disputes.

3. CONSIDER RAISING THE AGE OF RETIREMENT - The Turner Commission has recommended this, and it is being considered across the public sector.

With age discrimination reform coming in from this October, and given that staff will be able to work and claim an occupational pension from the same employer, the climate for longer working is already beginning to change.

Megan Griffith, project manger of NCVO's Third Sector Foresight project, says: "There has been so much publicity about pensions that there is a greater understanding of the need for many to work later in life."

Barnardo's is one of the organisations that has kept its final-salary pension scheme open. In 2003 it sought to address its deficit by asking staff employed before 2001 to consider deferring retirement until they are 65 rather than 60. Those who kept a retirement age of 60 were asked to pay bigger contributions or take a lower accrual rate.

4. CONSIDER PUTTING IN A LUMP SUM ON TOP OF THE CONTRIBUTIONS - Charities are increasingly seeking to meet their deficits by ploughing in an additional sum each year.

One charity that already does this is the British Heart Foundation, which is paying an additional £500,000 a year into its closed final-salary scheme fund, as well as raising its own and employees' contributions.

Kogher says this way of addressing deficits is likely to become much more common because it is the favoured method of the Pensions Regulator, which was established last year. "Some clients are in talks with the regulator now, asking questions such as 'are you putting additional sums in - and if not why not?'," she says. "There is more pressure now to do this."

5. BE INNOVATIVE - When dealing with a deficit it is important to think creatively if you are to find a solution that fits your organisation best.

One option could be to close your final-salary scheme but keep it open for certain roles for which it is traditionally hard to recruit. In 2002, the NSPCC closed its scheme to new members but retained a final-salary option for new recruits working directly with children - many of them come from local authorities, where they often get final-salary pensions.

Finance director John Graham says this has helped the charity to continue competing in the labour market and address its deficit, which it hopes to clear within five years.

The Charity Commission says another way charities can deal with a deficit is to look across their finances to see where money can be diverted, possibly by raising money on property and assets. Ray Jones, policy accountant at the commission, says he is not aware of any charity using this method yet, but adds that it is "only a matter of time".

Other options being considered, according to Nichols, are "to change to a career-average scheme rather than a final-salary scheme, which still keeps it competitive". Another option could be to link it to some other form of benefit, but Nichols concedes that this would still leave charities at a disadvantage in the recruitment market.

Reviewing your administrative costs and handing over the running of your scheme to an outside body could also help. Action for Blind People doesn't have a deficit problem, but it was still concerned about the £120,000 annual cost of running its pension provision. Earlier this year it took action and managed to cut this cost in half by transferring it to the Pensions Trust.

"That money can go back to front-line services," says Chris Harris, the charity's director of finance and resources. "But it is not just the money we are saving - the whole thing was giving us grief because pensions are a real headache to run."

The Pensions Regulator was set up last year to replace the Occupational Pensions Regulatory Authority and to regulate and assist the pensions sector better. Its website (www.thepensionsregulator.gov.uk) offers free information for trustees, employers and members, including toolkits and updates on regulatory change. The Charity Finance Directors' Group also offers advice on regulatory change. It produced a report in 2004, called The Charity Pensions Maze (see www.cfdg.org.uk).The NCVO's Third Sector Foresight project has produced a report into the Turner Commission's findings on the charity sector, called A Pensions Crisis?

Implications of the Pensions Commission Report for the Voluntary and Community Sector (see www.ncvo-vol.org.uk/3sf).

TYPES OF PENSION

Final-salary scheme - A defined-benefit scheme where members are promised a pension based on length of service and final salary. Financially, the employer bears the brunt of the risk.

Money-purchase scheme - A defined-contribution scheme where the employer and members make a set contribution. This is less financially risky for employers because the payout is based on the size of the fund rather than final salary or length of service.

Stakeholder pension - Commonly used by smaller charities that do not have the resources to run occupational schemes. These are run as personal pension plans, although employers make a contribution and charges by pension providers are kept low.

FINAL-SALARY SCHEMES - TO CLOSE OR NOT TO CLOSE

TO CLOSE... Save the Children

Three years ago, Save the Children decided to close its final-salary scheme to alleviate its pension deficit, which the latest figures show stands at about £14m.

Save the Children felt that closing the scheme would not harm it in the recruitment market because only a small proportion of its staff are UK-based or recruited in the UK. Finance director Nick Kavanagh says: "We have 3,500 staff worldwide, and a small proportion are based in this country or recruited from the UK. We had to act for the good of all our staff and donors, and that was a key factor in closing the scheme to new members."

The charity has also addressed its deficit problems by increasing the contributions and paying in an extra sum each year. These figures are under review, but Kavanagh says the annual lump sum is "certainly nowhere near £2m".

NOT TO CLOSE... RSPCA

The RSPCA's last actuary valuation three years ago revealed a shocking £20m pensions deficit and a tough decision over whether to close its final-salary scheme.

The charity decided to keep the scheme open, citing the need to ensure its pension scheme could compete in the job market. Instead, the charity addressed its deficit by increasing the level of contributions by employees from a minimum of 5 per cent to 6 per cent. It is also setting aside £2m a year over nine years to plough into the fund.

But financial director Mark Watts says these efforts only ensure the deficit does not increase. Further action is needed to clear it and the next evaluation this year could once again leave a question mark over the final-salary scheme. "We are having to keep all our options open," adds Watts.

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