The Regulator for Charities in England and Wales
(Version January 2007)
A number of charity pension schemes have in recent years reported significant pension deficits as scheme assets values have fallen at the same time as scheme liabilities have risen with increased longevity and the cost of annuity purchases increased. Changes in pension legislation protecting employees have added to the complexity of restructuring pension arrangements and also brought new factors into play when charities seek to restructure through incorporation or merger.
Fundamental changes have also taken place in funding requirement of defined benefit schemes. The Pensions Act 2004 introduced the Pension Protection Fund and new regulations regarding the deficit on wind-up or withdrawal from a scheme. Debts owed to the pension scheme on winding up or other deemed withdrawals are now calculated on a full buy-out basis – that is, the amount estimated by the actuary that is needed to secure the pensions promised with an insurance company.
These changes affect all charities that operate defined benefit pension schemes, including those that participate in defined benefit multi-employer schemes, and careful planning and advice in relation to any proposed restructuring of a charity such as on incorporation or merger is now likely to be necessary.
The following Questions and Answers explain some of the terminology used in relation to pension arrangements, the role of the Pension Regulator and provide answers to the questions that trustees most frequently raise with us.
These include final salary schemes. The principle is that the members are entitled to a particular level of benefit depending on their length of service and their salary. It is the pension benefit which is defined and it is then necessary to ensure that the contributions from both the employer and the employee are sufficient to provide that benefit.
These are pension schemes into which an employer pays regular contributions fixed as an amount or percentage of pay. Employers have no legal or constructive obligation to pay further contributions if the scheme does not have sufficient assets to pay all employee benefits relating to employee service. Benefits are determined by reference to contributions paid into the scheme and the investment return on those contributions.
For many employers a defined contribution pension scheme is a preferable option to a defined benefit scheme. In a defined contribution scheme the level of benefit depends on the contributions made rather than contributions needing to catch up with the actual benefits as in the case of defined benefit schemes.
This is an accounting standard, issued by the Accounting Standards Board that sets out the accounting requirements for entities, including charities, that operate defined benefit pension schemes. Charities operating defined contribution schemes will not be significantly affected by this accounting standard.
FRS 17 has no direct impact on the cash costs of contributions to a defined benefit scheme, all it does is to bring greater transparency to accounting for retirement benefits, and bring into sharp focus the costs and risks associated with defined benefit provision.
Further guidance on how charities should account for pension schemes is provided in the Charities SORP (PDF - 674KB).
The Pensions Regulator is the new regulatory body for work-based pension schemes in the UK. The Pensions Act 2004 gives the Pensions Regulator a set of specific objectives:
It also provides practical guidance for trustees, employers (including charities), administrators and others on complying with the requirements of pension law.
A significant number of charities have defined benefit pension schemes for their employees. For trustees of a charity to have set up a defined benefit pension scheme, they will have taken a decision that the scheme in question is in the interests of the charity. This may be for a number of reasons such as the need to attract and keep staff of an appropriate calibre, need to offer similar terms and conditions to other employers in the same field etc.
For a number of reasons many schemes are in a position where scheme assets may be insufficient to meet their potential liability under the scheme. There were a number of reasons for this including investments not performing as well as previously, changes in the tax rules and persons in receipt of pensions living longer. The result for many charities is increased contributions which, on occasions, trustees judge to be unsustainable in the longer term.
Many schemes found themselves in deficit and employers looked for ways of limiting their liabilities under the scheme. Neither Government, legislation nor the Pensions Regulator require ongoing schemes to fund to the solvency (full buy-out) level whereby all accrued liabilities could be secured immediately by the purchase of insurance policies. However, the full buy-out level of funding can become due in certain circumstances.
For this reason, it can be an expensive option to wind up a defined benefit pension scheme because the liability falling on the employer on a winding up is to ensure there are sufficient funds to purchase annuities for all employees to meet their entitlement (the full buy out value). This is significantly higher than funding the scheme on an ongoing basis. Because of this many employers have kept their schemes open for employees already in the scheme but closed it to new employees.
The Pensions Regulator is the regulator of all work-based pension schemes in the UK. It provides practical guidance for trustees, employers (including charities), administrators and others on complying with the requirements of pension law.
The Commission does not publish separate guidance on the application of pension law as it applies no differently to charities than to other entities. We do however provide guidance on particular issues that impact on the charity reporting framework. Recommendations on accounting for pension and other retirement benefits are contained within the Charities SORP (PDF - 674KB).
In May 2005 the Commission also produced some guidance on "Charity Reserves and Defined Benefit Schemes" explaining how a charity’s reserves policy might address pension deficits. The guidance also contained information about the possible liabilities of charity trustees.
The Pension Protection Fund exists to provide compensation to members of schemes where the employer becomes insolvent so that the scheme is under-funded. The Pension Protection Fund is funded by existing pension schemes which pay a yearly levy depending on their risk profile.
Further information about the role of the Pension Protection Fund, the levy and how it is calculated can be accessed from their website.
An issue that has arisen for charities is how to reduce the risk profile of any pension scheme which they operate and consequently the amount of the levy. One means of reducing the risk profile is for the liabilities of the scheme to be secured on the assets of the charity. This may involve charging charity land in which case it will require an order of the Charity Commission under section 38 of the Charities Act 1993.
In considering whether to authorise such a charge, the Commission needs to be satisfied that the proposed charge is in the interests of the charity. In order to establish this, the Commission looks at the following factors:
a) What expert advice has the charity taken? This may be from a lawyer, accountant, actuary or other financial professional or a combination.
b) What steps has the charity taken or looked at before deciding to take this course of action? These may include considering reducing future liabilities by closing the scheme to new employees, making a lump sum payment, increasing employee contributions, agreeing a reduction in the level of defined benefit.
c) What is the benefit to the charity of charging its assets in the manner proposed?
d) Is there any detriment/risk to the charity in charging its assets in the manner proposed?
e) Is the decision of the charity trustees to proceed with the charge one which a reasonable body of trustees might take in the circumstances of the particular case?
Incorporation means creating a new separate charitable legal entity to which the assets of the unincorporated charity will be transferred. Where the unincorporated charity has a defined benefit scheme, an issue may arise as to whether the transfer to the new corporate charity is a notifiable event.
A notifiable event includes:
(a) any decision by the employer to take action which will, or is intended to, result in a debt which is or may become due to the scheme not being paid in full.
(b) a decision by the employer to cease to carry on business in the United Kingdom
It is the view of the Pensions Regulator that an incorporation will invariably be a notifiable event.
There is a clearance procedure, established by the Pensions Act 2004, which allows an application to be made to the Pensions Regulator. Further guidance on making a clearance application is available on the Pension Regulator’s website. If the Pensions Regulator is satisfied that the incorporation is not financially detrimental to the Pensions Scheme, the Pensions Regulator can issue a clearance statement.
Whether or not there is an application for clearance, there is a legal duty to give notice of a notifiable event. This gives the Pension Regulator an opportunity to consider whether any action needs to be taken to safeguard the Pension Scheme. This action may involve either financial support directions requiring financial arrangements to be put in place to support an employer’s pension liabilities or in appropriate circumstances a contribution notice requiring a payment from the employer or a person connected to the employer to the scheme trustees or the Pension Protection Fund.
In the case of a single employer pension scheme, transfer of the undertaking to a company preserving the rights of employees under the pension scheme can be completed without the full buy-out value crystallising.
In the case of multi-employer schemes, the situation is more complicated. These are dealt with below.
Another consequence of incorporation may be to raise the risk profile of the employer as the new organisation will have no track record. However, this can be mitigated by explaining to the risk assessor the circumstances in which the new organisation has come into being.
Yes, a merger may often result in the creation of a new separate charitable legal entity and/or the winding up and removal of an existing charity. As with incorporation this may give rise to a notifiable event.
The Commission is able to advise on the charity law aspects of incorporation or merger but is unlikely to need to be involved in obtaining clearance in relation to pension arrangements unless some action is required on the part of either the unincorporated charity, the new incorporated charity or in the case of a merger, the successor charity which might otherwise not be within the powers of the charity. In such circumstances, if the Commission is satisfied that the proposed action is expedient in the interests of the charity, it may be able to authorise the charity to take the action. In the context of incorporation, there have been issues about additional liabilities arising in respect of the pension scheme and charity trustees being concerned as to how reasonable it is for them to take on such liabilities.
Similar issues may also arise in the context of mergers or other transfers of staff, activities and assets on the winding up of a charity.
It is not unusual for a number of charities to have established defined benefit multi-employer pension scheme for their respective employees. This may be more viable than each charity establishing its own scheme. In multi-employer schemes additional liabilities can become payable if an employment-cessation event occurs. An employment-cessation event occurs if an employer ceases to be an employer at a time when at least one other employer in the scheme continues to do so.
If such an event occurs, the full buy-out value of the scheme crystallises as a liability of the employer in relation to which the event occurs. It is likely that if an unincorporated charity is an employer in a multi-employer scheme, the transfer of their undertaking to a new incorporated charity will constitute an employment-cessation event.
It may be possible to make a withdrawal arrangement which will mean that the full buy-out value will not be immediately payable. However, charity trustees may be concerned at the prospect of having to incur liabilities in such an incorporation which would not otherwise become payable. In particular, they may be concerned as to whether this is an acceptable course of action which would be in accordance with their fiduciary duties to the charity.
The Pensions Regulator has produced guidance aimed at employers, trustees and advisers in its publication “Multi-employer withdrawal arrangements (PDF - 164KB) ” which can be downloaded from their website.
There are. An employer may close the scheme to its new employees but continue it for its existing employees. There is no objection generally to this and the scheme will continue. However, as the employees leave or
retire, there will come a point when the employer ceases to be an employer of staff within the scheme at a time when there is least one other employer in the scheme employing staff. Accordingly, at that point the employer becomes liable for their share of the full buy-out value of the scheme.
Some schemes are on a joint liability basis so that if a particular employer becomes insolvent, the remaining employers will be responsible for any deficit due to the pension scheme. However, the purpose of the rules is to ensure that it is not just a case of the last employer left in the scheme picking up the bill.
The Charity Commission recognises the seriousness of the issues confronting the sector in respect of defined benefit pension schemes. It would wish to assist in identifying good practice and facilitating this to the extent it is able to do so.
As has been indicated, the Commission can authorise charity trustees to take certain actions which may not otherwise be within their powers. Where trustees are concerned that they may be exceeding their powers, they can apply to the Commission for advice under section 29 of the 1993 Act or for an order under section 26.