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Between a rock and a very hard place - the looming pension crisis

Finance | David Davison | 3 Mar 2010

The great Eagles song Hotel California has the immortal lines “You can check out any time you like, but you can never leave”, which perfectly sums up the growing pensions crisis gathering momentum in the voluntary sector.

There has been a huge increase in the numbers of not-for-profit organisations over the past few years, fuelled by local authorities’ almost insatiable appetite for outsourcing of public sector services, a trend that is only likely to continue considering the current state of the public purse. 

There are few service areas which have remained untouched, with major charities and other specialist bodies, providing services in housing, care of the elderly, healthcare and childcare to name but a few.  The majority of these bodies are small, run on tight budgets and many receive in excess of 90 per cent of their funding from the public purse.

For many, however, there has been a major unseen consequence resulting from the drive to fulfil this demand. In order to compete for contracts, not to mention be competitively placed to compete for staff, the majority of these organisations were forced to offer final salary pension benefits, mostly through the local government pension scheme or large multi-employer arrangements, even though in most cases they were singularly ill-equipped to do so.

Without being fully aware of the implications, many organisations assumed responsibility for local government staff and their pensions within fixed cost and term agreements which will prove totally insufficient to cover their costs. Contracts were negotiated taking in to account a contribution rate set at outset, but which has risen steadily ever since, with these increases having had to be absorbed by the organisation within its overall budget.

Of greater concern is that, should the contract not be renewed, or if organisations look to change status or seek to terminate it, many will be unable to meet the liabilities which have built up to the termination date. Indeed the existence of the final salary pension scheme makes it all the more likely that contracts will not be renewed. This is the case because a supplier with a significant pension cost is likely to be less competitive than a supplier without any such commitment. Purchasers will clearly always favour the most competitive supplier.

It is the familiar scenario of rising pension scheme costs and significant deficits which exists in the private sector. The key difference is that in the private sector there is rarely any compulsion to provide benefits on a final salary basis going forward, and past benefit deficits can be met from additional calls on shareholder funds.  Neither of these options exist in the outsourced sector. Organisations frequently do not have additional resources upon which to call and it is next to impossible to leave their scheme, given the exit costs.

Charities need to recognise the problem and ensure they have a strategy to deal with it. Steps can be taken but early engagement with the problem is essential.

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