January 27, 2013 9:46 am

Charities struggle with pension fund deficits

Barnardo's©Alamy

Charity does not begin at home: the risk from defined benefit pensions is too great, says Barnardo’s finance director

Charities are running into headwinds to reduce their pension fund deficits and meet liabilities with Barnardo’s, the children’s charity, the latest to announce the closure of its final salary scheme to all members in March. More closures are expected.

The Barnardo Staff Pension Scheme’s liabilities stood at £548m with a shortfall of £83.9m at the end of March 2012, up from £73.4m a year earlier. Members, who are currently in discussion with the charity, will shift to its defined contribution scheme this April.

“More charities will close their defined benefit schemes this year and over the next few years, including large ones,” says Jane Tully, head of policy at the Charity Finance Group.

Pension scheme liabilities pushed People Can, a charity helping victims of domestic abuse, ex-offenders and the homeless, into administration two months ago, while The Work Foundation, an influential think-tank, was sold off in 2010 after being pushed into insolvency by its pension obligations. The NSPCC, the children’s charity, also closed its final salary pension scheme in 2009.

“This is just the tip of the iceberg. Charities tend to get forgotten about when it comes to pension funds and their problems,” says John Ralfe, an independent pensions consultant.

Kevin Barnes, Barnardo’s finance director, says managing the pension fund deficit is vital, a view shared by the Charity Commission, the sector’s regulator. It warns that operating a DB scheme creates financial risk that in some cases may, if not managed, become a big risk to the charity and its future activities. The commission attributes increasing liabilities to a mix of falling asset values, scheme members’ longevity, low interest rates and lower than expected returns.

Other factors are also at play. Many charities, like private sector companies, have been slow in building up contributions. “Look at all the pension scheme [contributions] holidays in the 1990s when they were in a much healthier condition. Why didn’t companies do something then and why did they continue with a [heavy] equity weighting,” says Richard Maitland, head of charities at Sarasin & Partners.

The view that too little is being done too late is shared by Mr Ralfe. In terms of Barnardo’s DB scheme “it has paid in too little for regular contributions for new pension promises”, he says.

“When it closed to new members in 2007 it was paying under 12 per cent of salaries and it has tried to make up the shortfall by adding equities.”

A large number of charities are redirecting some of their funding into the pension scheme deficit, according to Mr Maitland, while others are relying on their reserves. At Barnardo’s the £84m pension deficit “destroys almost all of its £100m net reserves”, Mr Ralfe says.

Closing the DB plan and shifting to a DC scheme is done to avoid diverting donations and funding to final salary plans, and to mitigate risk, points out Ms Tully.

In addition to tackling the financial risk related to final salary schemes there is also the issue of reputation. The Charity Commission in its guidance on charity reserves and DB schemes points out the reputational risk from not honouring pension promises “will not be insubstantial”.

So is the DB pension scheme the wrong model for charities in this low return environment and uncertain economic times?

“It is an attractive model for employees and unattractive for employers,” says Mr Maitland. For charity employees, who are not highly paid, the DB scheme has been appealing, he adds.

For charities looking to merge in the sector, plugging the gap in liabilities is a big constraint for potential acquirers, especially the shrinking ones where there are fewer employees to contribute to the scheme, points out Mr Bevan.

About 5,000 charities have sought a way out of their deficit problems by participating in multi-employer DB pension schemes, hoping to gain the benefit of sharing risks and controlling costs. But the Charity Finance Group believes it is an unsuitable solution for charities, which are often unaware of the financial implications of such a scheme and find it difficult to leave because of high exit costs. Faced with such tough options, closure of more DB schemes will be likely for many charities in the next year or so.

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