On the go: Charities could cut their defined benefit cash contributions by between 35 and 65 per cent if they opt for the bespoke option over the fast-track route in the new DB funding code, according to analysis by Hymans Robertson.
However, the new regime will also see pension deficits for the 40 largest charities in England and Wales increase by an estimated £1bn, bringing the overall deficit up to £3.5bn. Hymans Robertson attributes the increase to changes in the way deficits are calculated under the new code.
Under the bespoke route, schemes could pledge security to support a lower funding target or a longer recovery plan, thereby cutting their cash contributions, the consultancy explained.
Using the example of a charity that has a £100m DB scheme that is 90 per cent funded on technical provisions, Hymans Robertson assumed that the fast-track option requires this charity pension scheme to be fully funded on a gilts plus 0.5 per cent long-term objective within 15 years, with a cash recovery plan of no more than six years.
However, using the bespoke approach enables adoption of a lower gilts plus 0.8 per cent long-term objective, with £16m of security bridging the gap between this lower funding target and the fast-track equivalent.
Pledging further security can then also support a longer cash recovery plan than six years, thereby further lowering the annual cash costs, the consultancy said.
Alistair Russell-Smith, head of corporate DB at Hymans Robertson, said: “The funding position of pension schemes in the ‘not-for-profit’ sector is, on average, worse than other sectors in the UK, and with the new regime these deficit figures are set to increase by an estimated £1bn for the largest 40 charities as their schemes put long-term funding targets in place.
“For the first time, however, the proposed new funding regime gives charities tangible value from providing security to their pension scheme because there is a direct link between the amount of security provided to the scheme and the subsequent reduction in cash contributions.
“This means that pledging security to pension schemes may be a way for some charities to navigate the new funding regime while keeping cash contributions at current or even lower levels.”
A “tough year” for charities has meant “cash to fund the pension scheme is… scarce”, but some charities “do have significant balance sheets and unencumbered assets that can be used to support the pension scheme and reduce cash costs”, Russell-Smith continued.
“For example, a charge over charity property or investments can support a lower funding target or longer recovery plan, which reduces the cash requirement down to more affordable levels.”
Opting for a bespoke funding plan “would allow charities to do this and we calculate it could enable them to reduce cash contributions by 35 to 65 per cent”, Russell-Smith said. “This approach allows investment returns to plug more of the funding gap, as well as giving the pension scheme trustees the covenant visibility that they need under the new funding regime.
“In contrast, the alternative fast-track route would increase cash costs for many charities.
“While this route ensures no regulatory intervention, it comes with a real cash cost at a particularly unwelcome time for charities,” he added.
