Beware of the law of inadvertent consequences.

Brian Spence

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Hindsight is a wonderful analytical tool, but its practical applications are limited, of course, to pinpointing problems after they have arisen rather than being able to prevent them from happening in the first place.

We do not have the ability to foretell the future, but we can make changes when we recognise where mistakes have been made in the past and for those that are ready to act quickly there are significant benefits to be had. Nowhere is this fleet footed approach more important than in the world of pensions.

Recognising there is a problem is the first step in any recovery but unfortunately there is in my experience limited awareness among charitable and not-for-profit organisations of the significant and potentially catastrophic risks posed to their organisations by their final salary pension schemes.

Many small charities and not-for-profit organisations have been encouraged to participate in local authority or multi-employer final salary schemes. This probably seemed like a good idea at the time, but in light of the successive changes made to pension legislation such a strategy is now totally inappropriate.

We have already seen one charity, Family Service Units, fail as a result of its pension liabilities and it’s difficult to imagine that there won’t be more. Under current legislation it’s surprisingly easy to accidentally trigger a significant pension scheme deficiency which could in some cases be catastrophic to the organisation concerned.

There has been an increased understanding in the corporate world of the risks posed by final salary pension liabilities as a result of the requirement to disclose them in corporate accounts under FRS17. The risks for charities are identical, but as they are generally less apparent they are less well understood by the sector.

This is because a charity will typically have a series of disclosure options open to it depending upon the structure of the pension arrangement being provided. If it has its own scheme then, in all likelihood, it will be required to make the appropriate disclosures because it can clearly identify the scheme assets and liabilities.  However, where the charity is part of a local authority scheme, or similar multi-employer arrangement, then the identification of its particular share of the assets and liabilities can be more difficult to identify.

Consequently there is a significant lack of consistency in this area which causes a great deal of confusion.  Some local authority schemes have now set up mechanisms for participants to access FRS17 numbers on a consistent basis at a reasonable cost, however this is not universally the case.

Indeed one prominent multi-employer scheme readily admits that it cannot identify individual member movements or individually account for payments from the employers who participate in its scheme, which makes the provision of accurate FRS17 numbers very expensive, if not pretty much impossible.

This places the scheme sponsor and indeed the company auditor in a very difficult position as they need to know if they are in a position to disclose appropriate information. It could even be argued that failure to disclose such information misrepresents the financial position of a charity.

Where scheme sponsors and company auditors are unable to get accurate figures they need to both be aware of the extent of any material liability existing. The message is therefore that even if disclosure is not possible awareness is essential. Simply pretending the problem does not exist is not an option.

Unfortunately for many organisations the extent of the problem only becomes visible during commercial activity such as a merger of organisations or the incorporation of a business.

In the not-for-profit sector such activity is often pursued with very little awareness of the potential pension implications. However, both such events would be classified as a withdrawal under the current multi-employer withdrawal arrangements and the debt involved is likely to be considerably higher than even the FRS17 measure.

It is important to note that even where there is no intention to change the pension scheme provision as part of the commercial activity certain decisions can trigger this debt payment as a matter of course. Once this has happened it becomes much more difficult to go back and renegotiate a revised commercial settlement than it would have been had the status quo not been disrupted in the first place.

The withdrawal process is cumbersome and will involve a significant amount of paperwork and administration as well as professional advisory support at an early stage.

Those responsible for the financial management of these charities need to have a much stronger handle on the issues to understand how they are affected.  They need firstly to clearly identify the pension scheme’s financial position and any options available to them.

They also need to identify the potential staffing impact of any changes which they might decide to make.  The Charity needs to be clear about the contractual arrangements under which they provide services and how these impact on the responsibility for pension scheme funding and they need to consider how the pension funding position should be accurately and realistically presented in the charity’s accounts, especially where a previous disclosure has been made.

The appropriate funding and disclosure of pension scheme liabilities has the potential to impact significantly on all aspects of a charity’s work, not just in the limited sphere of the pension fund itself.  It is an area where it may well be in the best interests of the charity board to seek independent advice, rather than to rely entirely on advice provided to the pension scheme trustees.

By its very nature advice to the trustees will, quite rightly, be approached from the perspective of the scheme rather than the employer. In the current UK economic climate it is often the case that the scheme’s needs and those of the employer are no longer directly aligned.

This is no longer an area which can be ignored in the hope that “it’ll be alright on the night.” All these areas need to be thoroughly examined, the risk areas identified and action taken.

Looking back and wishing action had been taken earlier will be no good once a charity’s financial standing has run aground on the poor management of its pension arrangements.

ENDS

Brian Spence

Post by Brian Spence

Fellow of the Institute and Faculty of Actuaries and Society of Actuaries in Ireland, scheme actuary, professional pension trustee

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