23 July 2020 - Events
Earlier this month Hymans Robertson published an insight piece on DB pension funding in the charitable sector. The report presents key findings on the defined benefit (‘DB’) pension exposure of the 40 largest charities in England and Wales by income.
The main themes of the report are the impact that Covid-19 has had on charity income, the resulting increase in many DB scheme deficits, and changes to the funding regime which will be introduced into legislation in 2021. The report also considers how charities should respond to the current situation, and suggests suspending contributions to conserve cash, or considering DB consolidation options.
Early on in lockdown the Pensions Regulator introduced some easements which allow trustees to agree contribution reductions or suspensions without having to report such agreement. Those easements are currently due to expire at the end of June, but there is some expectation that they may be extended. The Regulator recognises the very significant challenges faced by many charities (and others) sponsoring DB schemes, and is supportive of employers and trustees taking steps to ensure an employer’s survival. Nonetheless, the duties on trustees, including to act in the interests of members, are not diminished by reason of the economic crisis, and on 16 June the Regulator published updated guidance which underlines those duties. It is expected that many trustees will by now have a greater understanding of the sponsoring employer’s financial position than they did three months ago, and the new guidance emphasises the need for trustees to apply that understanding and to continue to develop it through regular engagement with the employer.
It is thought that approximately 10% of schemes have agreed to suspend or reduce contributions; a route which can be attractive to employers, particularly, charities whose income has been hit very hard by the crisis.
Should you seek or agree to a contribution holiday?
Many charities have suffered significantly over the past few months as the virus has necessitated the cancellation of fundraising events and the closure of retail shops. Many charities are also asset rich with low liquidity. In the short-term it may be vital for a charity employer to conserve cash, and reducing or suspending contributions to the pension scheme could be one way of achieving this. If you are an employer seeking a contribution holiday it is important to bear in mind that this is not a long-term solution. The contributions remain due to the scheme, and indeed the Regulator expects that the current Recovery Plan should not be lengthened at all, meaning that any unpaid contributions should be paid during the current Recovery Plan period. Where a suspension or reduction is necessary and appropriate, trustees should seek protections and other mitigations. For example, there should be agreed triggers for when contributions will start again. Further, pension trustees should be very careful about agreeing concessions at the same time that other creditors are seeking enhanced protections. As such, any reduction or suspension should generally coincide with other creditors agreeing concessions to support the employer.
Any agreement to a contribution holiday must, from 1 July, be reported to the Regulator.
Should trustees agree to extend a contribution holiday?
It is permitted for pension trustees to agree to consecutive contribution holidays, but the Regulator makes it clear that he does not expect pension trustees to unquestioningly extend suspension agreements. Instead, they should undertake due diligence on the employer’s financial position before agreeing a new suspension or reduction. Ultimately, and particularly if the scheme ends up in financial distress, pension trustees will need to demonstrate that their actions were reasonable and in members’ interests.
Contribution holidays – practical considerations
Anyone considering a contribution holiday you will first need to check the governing scheme rules. Most rules allow for employer contributions to fluctuate, but a deed of amendment may be necessary. It may also be necessary to make changes to the Schedule of Contributions, for which the pension trustees will need the input of the scheme actuary.
Where due diligence has been carried out, and pension trustees have good evidence that there has been a material worsening of the employer covenant which is not expected to recover in a reasonably short timeframe, the Regulator expects that pension trustees should consider whether it would be in members’ interests to update the scheme’s funding arrangements (e.g. to call an actuarial valuation or to revise the Recovery Plan).
The current uncertainty is not going to end any time soon, and so it is very important for pension trustees and employers to work together to ensure that scheme trustees have an up-to-date understanding of the employer’s financial position which will enable them to support the employer and scheme in the most effective way. Any decisions taken by pension trustees should be done with an understanding of how those decisions will support the employer and therefore the covenant supporting the scheme, and should be weighed against the potential risks to the scheme. There may be good reasons for pension trustees to agree a contribution holiday. There may even be good reasons for the scheme to be treated differently to other creditors; what is crucial is that they are satisfied by those reasons.
Whether you are a charitable employer with responsibility for an open or legacy defined benefit scheme, or a pension trustee running such a scheme, this a challenging and complex time. Estella Bogira, a senior associate in our Pensions team, would be very happy to arrange a no obligation discussion to help shape your thinking around the issues and options with regards to DB funding in the current climate.