An Institute of Chartered Accountants of Scotland report laying out guidance for charity trustees on going concern has prompted a second look at their participation in the Local Government Pension Scheme, with experts warning that many could face crippling debt payments as they run out of members.
The Icas guide is intended to help charity trustees carry out assessments of their ability to remain a going concern, noting that “trustees should consider all available information about the future, covering at least 12 months from the date on which the trustees’ annual report and accounts are approved”.
Though the guide makes no mention of pensions itself, experts have highlighted that the current situation of their scheme could have a direct impact on charity trustees’ ability to prove they will be able to meet their financial obligations.
This is due to the fact that declining numbers of active pension scheme members may become a material concern for charities, with debt payments coming due once all members have left likely being unaffordable to many.
The position is just going to get worse year on year, because more and more organisations are going to get to a point where they have very, very small numbers of members
David Davison, Spence & Partners
Running out of members is expensive
David Davison, director and owner of Spence & Partners, who highlighted the issue in a bulletin last month, noted that while going concern may seem likely on an ongoing funding and accounting valuation basis, things become much less secure on a cessation valuation basis.
This is because “if you exit the scheme, then the liabilities are calculated on a gilts basis, so a nil-risk basis, which puts the values of those liabilities up very significantly”, Mr Davison told Pensions Expert.
Taking the example of a charity with an accounting deficit of £300,000 but a balance sheet value of £500,000, the net positive £200,000 makes the organisation a going concern, he explained.
However, if that organisation is down to one or two members of staff, and an auditor concludes there is a real risk they may leave in the next 12 months, “then your deficit on an accounting basis was £300,000, but your deficit on a cessation basis is £1m”, he said.
“You’ve now got an organisation that only has £0.5m of assets and £1m of pension deficit, which is effectively being triggered. So it means that the auditor will say it’s quite difficult on that basis to actually sign a going concern certificate, because effectively you may not be a going concern if this debt triggers.”
And this will happen unless an alternative arrangement or a debt deferral has been agreed in advance, he added.
Mr Davison warned that the problem might be widespread, since as many as 2,000 charities could be participating in the local authority schemes.
“The vast majority of them will be closed to new entrants, and will probably have closed some time ago — and so they’re all gradually rolling their way down to this position. I’m coming across it reasonably frequently now,” he noted.
He added that this situation is likely to happen more often in future as these schemes run out of members.
“This isn’t a theoretical issue, this is something that’s already happening. The position is just going to get worse year on year, because more and more organisations are going to get to a point where they have very, very small numbers of members. And because they’re closed, they can’t add anybody else to the scheme,” he said.
“So it just inevitably may get to a point where they don’t have any members, and probably their auditors are going to start looking at them more and more closely in terms of whether they would continue to be viable, if that debt triggered.”
Mr Davison cautioned that pre-emptive action was required on the part of charities to solve the problem, but that “the vast majority probably won’t be aware of it and may not be aware until their auditor raises it with them as being a potential issue.”
Deferring debt has downsides
Though recent regulatory developments mean it is theoretically easier for charities either to defer or otherwise spread out cessation debts, this easement is not without its potential drawbacks.
Alistair Russell-Smith, head of corporate DB at Hymans Robertson, argued that if an easement is recognised by auditors, then he hopes “that a going concern statement remains achievable from a pensions perspective, even for charities that are down to fewer than five staff in an LGPS fund”.
“This is because it should be possible to defer the debt beyond when the last member of staff has left the fund,” he noted.
However, he said that “while deferring or spreading pension debt over a longer period usually helps to make pension costs more affordable, charities should be aware that they are then also exposed to investment risk for longer, and therefore the risk of higher costs if market conditions worsen”.
Charities suffer under the strain of DB scheme deficits
Three-quarters of charities have defined benefit schemes in deficit, adding extra strain to a sector already hit hard by coronavirus, according to a new report by Hymans Robertson.
Mr Davison concurred, adding that it is of vital importance that charities looking to arrange a funding arrangement or a debt deferral discuss it with their LGPS fund in advance.
“The scheme may want some form of security or some form of protection,” he said. The scheme will want to know whether “the organisation actually has the security or the protection that would allow them to enter into the sort of agreement”.
The LGPS funds themselves ought to be aware of the issue as not dealing with it efficiently is a “zero-sum game”, Mr Davison added.
“If you don’t come up with some sort of sensible funding agreement, and then the organisation potentially disappears, they don’t collect the money anyway,” he said.
“So I think the funds need a dose of pragmatism around this as well, in terms of how they go about dealing with it.”
The LGPS Advisory Board has been approached for comment.
