Pensions: Two out of three ain’t bad
While the focus of the pensions world has been on master trusts, the government’s white paper on defined benefit pension schemes, the Pensions Regulator’s Annual Statement, and the devastating impact of pension deficits on organisations like Carillion, some quiet changes have been going on which could make a significant impact in the not-for-profit sector. Organisations here typically have pension liabilities in either their own standalone final salary scheme, a large multi-employer final salary arrangement, or the local government pension scheme.
While the top 50 charities in the UK have deficits totalling £1.4 billion on an ongoing basis, or £5.1 billion on a buyout basis, most have already closed their schemes to new entrants, and in many cases, ceased to accrue. Most not-for-profit organisations have struggled to deal with their deficits. However, these schemes are now able to implement an increase in payments from unrestricted funds to reduce some of the liability, and also implement liability management exercises, such as those which have been undertaken in private sector final salary schemes for some years.
Like all final salary schemes, they will have to undertake activities against the changing back drop set out in the Pension Regulator’s Annual Funding Statement and the government’s white paper “Protecting Defiant Benefit Pension Schemes”.
As expected, the Regulator expects trustees to focus on the integrated risk management process already in place, looking at employer covenant (and ability to support the scheme), investment risk and scheme funding plans. In addition, the Regulator also expects trustees to pay greater attention to scheme maturity ie. as more members become pensioners, creating cash flow risks in terms of the schemes underlying investments. The Regulator has produced a table with different employer characteristics, scheme funding characteristics, key risks and a clear message as to what it expects trustees to do in each of those scenarios. In short, where employers are strong, the Regulator’s expectation is that trustees will need to strengthen technical provisions, increase contributions and reduce recovery plan lengths. These steps may be coupled with short term security, especially where dividends are paid to shareholders or there is other covenant leakage (inter group loans, inter group asset transfers, etc.) and other appropriate measures would need to be taken. Where employers are weaker, the Regulator expects trustees to press the sponsoring employer to prioritise scheme liabilities over shareholder payment covenants, and put active monitoring processes in place for any employer covenant risk, including, putting in place contingency plans (which we would suggest should be discussed with any sponsoring employer) to address future risk.
Given the negative press generated in relation to recent entries into the Pension Protection Fund unsurprisingly, the Regulator is also suggesting trustees need to undertake a greater analysis of the level of contributions versus distribution of dividends within any sponsors business.
One new area the Regulator is calling on trustees to consider is the level of senior management pay and they highlight this in particular to smaller employers, and state trustees should consider senior management pay levels in the same context as potential shareholder distribution as, in its view, high senior management pay can weaken the employer covenant.
Finally, the Regulator underpins its message by stating it will be quicker to act and tougher on those who failed to act in accordance with their guidelines. The Regulator talks about being more proactive, using its range of powers more often, in particular, extending its reach to smaller schemes.
After many years of waiting, not-for-profit organisations have finally been rewarded by the innocuously entitled Occupational Pension Schemes (Employer Debt and Miscellaneous Amendment Regulations) 2018 which came into force on 6 April 2018. Not-for-profit organisations in multi-employer final salary arrangements, who were caught between a rock and a hard place, either:
- Continuing accrual and seeing the deficit spiral at an ever increasing rate or,
- Ceasing accrual and crystallising the entire deficit, the amount of which would be so large that it could lead to insolvency
Now have an escape from the spiral of ever increasing liabilities. The regulations introduce a new concept known as the Deferred Debt Arrangements (“DDA”). This allows not-for-profit organisations, whose only change is to cease to employ active members in their scheme, to cease future accrual for its members without triggering a cessation debt. It should allow future contributions to be set on an ongoing (not cessation) basis, effectively allowing the not-for-profit organisation to have a scheme within scheme. This allows them to have some form of risk control in place to pay down listing liabilities in a controlled way, rather than be trapped into building up further liabilities. Of course, with the lack of detail in the regulations, any not-for-profit organisation in a multi-employer final scheme should engage in dialogue with their advisers and scheme provider before initiating any action. There is an element of “seeing how this plays out on the ground”.
Local Government Pension Scheme
While not-for-profit organisations have an opportunity for change with standalone and multi-employer final salary arrangements, unfortunately the many not-for-profit organisations have built up deficits as a result of outsourcing agreements, and employees in the Local Government Pension Scheme will not have the same flexibilities. It is to be hoped that the DWP will have seen the opportunities that have been created in the other two areas of final salary provision, and now amend Local Government Pension Regulations to allow the same type of flexibility on exit ie. no automatic triggering of cessation arrangements, no locking charities into a further spiral of deficit and liability increases which become more and more unaffordable, and impact on both cash flow on a year-by-year basis, and also on the charity’s insolvency position.
As ever, with any type of final salary deficit, the situation faced by each employer will be unique to that employer, and careful thought should be given as to the most appropriate routes for quantifying and dealing with deficit going forward. Our team at Freeths has widespread experience of working with not-for-profit organisations around all types of pension provision and includes both charity and pension specialists.
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.
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