I was encouraged to see this article, CFDG to ascertain scale of sector pensions shortfall confirming that the Charity Finance Directors Group (“CFDG”) are to undertake some research as to the scale of the final salary pension problems affecting the sector.
I’m not sure that we really need to get too hung up on the figures - we all already know it’s a very large number!!
Instead I think we need to focus our efforts on the issues and potential solutions. I think that what needs to come out of this is a “blueprint for change” which will actually engage all the stakeholders involved and result in action. The CFDG has published some excellent reports on this pension issue dating back to 2003 but unfortunately not enough charities have heeded their contents or indeed even been aware of their existence.
In my view there are a number of very simple steps which could be taken to at least begin to address the issues:-
Firstly, “when you’re in a hole, stop digging” so let’s try to ensure that the problem affects the minimum number of organisations:-
1. There should be clear guidance to charities that the default position for the provision of pension benefits is not to join any form of defined benefit arrangement. Local Government schemes have already made it much more difficult for organisations to join as admitted bodies by refining the entrance criteria and requiring organisations to provide a guarantor in the event they were to become insolvent. Finding someone who will provide this guarantee, in my experience, is becoming increasingly difficult which is limiting the number of organisations able to join. It does not however exclude everyone and neither is it universally the approach taken outside the LGPS which means that organisations continue to sign up for defined benefit arrangements which are patently unsuitable for them.
2. All those organisations providing defined benefit arrangements for charities should be required to issue very clear warnings about the potential risk of participation. They should also be forced to take a much broader view of what is in the best interest of these organisations, considering their funding position, experience of DB, existing schemes already in place, their size and growth prospects. Regulation in this area appears to be much weaker than in the more highly regulated defined contribution area which ironically expose scheme sponsors to much less risk. Warnings also need to encompass the additional risk exposure inherent with schemes established on a ‘last man standing’ basis. In effect, an organisation selling a final salary solution to charities should be required to carry out an analysis of a prospective clients needs and the suitability of their proposed solution, including addressing the affordability questions and addressing alternative solutions that are available. This is simply akin to that the process an IFA must go through when selling any other sort of pension product to an individual and which is aimed at protecting individuals being sold a product that is unsuitable for their particular needs and circumstances. Charities should not be afforded lesser protection than individuals.
3. There needs to be an overhaul of public sector procurement in relation to the provision of pension benefits so that small charitable organisations (or indeed all organisations) are not forced to provide defined benefit arrangements.
Secondly, having limited the number of organisations affected, consideration needs to be given to how to deal with the legacy problem which has built up to date now the “stable door is open.”
Whilst lengthened funding periods may seem like an ideal solution they are not a panacea. Clearly the longer the funding period the higher the risk of insolvency in that period so the greater risk of a shortfall not being dealt with. Whilst an apparently attractive solution to the charities in the short term they need to understand that this comes at the price of compromising the security of members benefits. In multi-employer ‘last man standing’ schemes this also exposes other participants to a greater risk of having to pick up a share of unpaid contributions / liabilities. It will be interesting to see if the Pensions Regulator takes a more charitable view of funding periods than would be the case in the private sector.
Having said that I certainly believe that a greater flexibility of contributions would be welcome, but this is something that is not currently available within a number of major schemes. The ability to set a longer payment term but to fund additional monies when available for the specific benefit of that particular scheme sponsor could be very valuable and much more closely meet the flexible funding needs of these types of organisation. Other steps which should be considered are:-
1. Ensure a more realistic and transparent basis for scheme funding so that organisations are completely aware of how pension liabilities impact on their organisation.
2. Clearer governance structures which give the scheme sponsor more of a voice in the running of the pension scheme.
3. Organisations need to be fully aware of the impact of any change to their organisational structure (such as incorporation or merger) to ensure that they do not inadvertently trigger what could be a catastrophic Section 75 debt.
4. The Section 75 debt regulations need to be amended for cases where there is no material change in the employer covenant such as on incorporation or merger to prevent the triggering of a S75 debt where the position as regards employer covenant is essentially identical over the date of the change.
5. There needs to be a revision to the basis of PPF contribution within ‘last man standing’ arrangements which more closely reflects the more limited risk the PPF is undertaking. This would allow more funds to be directed to deficit repayment. There should also be the possibility of some of these larger schemes making a contribution which is effectively a self-insurance premium to further reduce risk and associated costs.
6. LGPS should have a more consistent and transparent basis of transition to exit which provides more flexibility than just the payment of a Section 75 debt. More use of flexible payment plans with security would be beneficial. The actual calculation of the debt is also frequently too conservative and does not actually reflect the inherent risk related to the organisation exiting or to the overall investment approach undertaken by the scheme.
Some of these may be more time consuming to achieve but I’m sure as part of any research solutions to these and no doubt other issues will begin to emerge and with a commitment to change we can help protect this valuable sector from the potentially destructive and divisive nature of DB benefits.