DB pension funding in the charitable sectorApril 2019

Key findings

Average DB scheme funding level

Average allocation to growth assets

18% of charities have a pension surplus

63% of charities have closed their DB scheme to

future accrual

15% of charities have granted security to their

DB scheme

The average pension deficit is 18% of unrestricted

reserves

The average pension deficit is 24% of annual net unrestricted income

The average charity pays 3% of net unrestricted

income into its pension scheme

86% 52% 18% 63%

15% 18% 24% 3%

Welcome

Layered on top of this is a significant DB burden for many charities, with regulatory pressure to pay off pension deficits more quickly. We’ve analysed the DB pension exposures of the largest 40 charities in England & Wales by income to assess the issues and how charities should respond. These charities have a combined £39bn of reserves and £13bn of annual income, and support aggregate DB liabilities of £9bn.

Charities continue to face financial challenges at the moment with fundraising and contracts under pressure, and the need for transparency becoming ever greater.

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Alistair Russell-SmithPartner and Head of Corporate Consulting

alistair.russell-smith@hymans.co.uk020 7082 6222

How should charities respond?Expect even more regulatory scrutiny.

The Pensions Regulator is becoming tougher off the back of pension failures like Carillion. They are expected to introduce a “comply or explain” regime whereby minimum funding standards are prescribed, with individual pension scheme trustees then having to explain (if required) why a different approach is appropriate for them.

Use security or contingency planning to support your DB cash costs.

Some charities do have unencumbered assets which could be used to support DB funding. This can lower cash costs by supporting longer recovery plans and help with any regulatory intervention. We see this becoming a more important tool for managing pension deficits in the sector.

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Consider DB consolidation.

As DB schemes become ever more in run-off, consolidation solutions to reduce costs or management time are being developed. Commercial consolidators give a clean break to employers at a lower cost than buy-out, and could be a good way for charities participating in multi-employer schemes to exit cost effectively. DB Master Trusts do not give a clean break, but by aggregating DB schemes they can reduce running costs by as much as 50%, helping bridge the pension deficit.

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Charity analysis

IntroductionThe ability of a charity to support its DB obligations is more important than the size of the liabilities or deficit in isolation. Our analysis therefore focuses primarily on the size of the pension scheme relative to the size of the charity, by considering the following measures:

Measure What it showsDeficit / unrestricted reserves

The level of charity assets available to potentially support the pension scheme (restricted assets and endowments are excluded as they are typically not accessible by the pension scheme)

Deficit / net unrestricted income

The level of charity income available to potentially fund the pension scheme (restricted income is excluded, and the cost of generating the unrestricted income has been removed to leave a net amount of income that could be spent on charitable activities or to fund the pension scheme)

DB pension contributions / net unrestricted income

The proportion of net unrestricted income that is paid into the pension scheme

Deficit/unrestricted reserves

ResultsThe charts below show the distribution of results on each of these measures.

1 charity has a deficit that exceeds their unrestricted reserves

2 charities (both

endowment

funds) have a

deficit that

exceeds their

net unrestricted

income

CG

LIA

GE

SCF

CU

AFC

TLC

CRTSAOIA

ROH

CG

GD

STU

CSF

RNLI

AQ

A

LCD

RCSBMH

WC

BHF

CG

LA

CE

CC

EW

TA

T

SAH

MC

SBR

CC

AF

CR

BC NT

NH

OX

FU

SW BAR

MC

OT SU

RMS

BU

90%100%

60%50%40%30%20%10%0%

80%70%

Deficit/net unrestricted income

DB contributions/net unrestricted income

WT

CRT

USW

CG

LINT

RNLI

OT

SCF

SURO

HC

GTL

CSA

GD

STU

CSFBUNH

AFCOIA

MH

RCSB

LCD

RMS

WC

AQ

ABH

FA

CE

CG

LA

T

SAH

MC

SBR

CC

AF

CR

BC

CC

E

MC

AG

E

BAR

OX

F

CU

90%100%

60%50%40%30%20%10%0%

80%70%

AFC

CA

FC

GLI

RCSB

BAR

AQ

A

OTSABUNT

TLCSUAT

CR

LCD

ROH

CG

RMS

OIA

GD

STSA

HM

CM

HBH

FW

C

AC

EBR

CC

GL

CC

EM

CS

BC

AG

ERN

LIO

XF

SCF

WT

NH

USW CRTC

U

UC

SF

9%10%

6%5%4%3%2%1%0%

8%7%

Average deficit is 18% of unrestricted reserves

Average deficit is 24% of net unrestricted income

Average pension contribution is 3% of net unrestricted income

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Code Charity Code Charity

ACE The Arts Council of England MCS MacMillan Cancer Support

AFC Action for Children MH Methodist HomesAGE Age UK NH Nuffield HealthAQA AQA Education NT The National Trust for Places of Historic Interest or

Natural BeautyAT Anchor Trust OIA Oasis International AssociationBAR Barnardo’s OT Ormiston TrustBC The British Council OXF OxfamBHF British Heart Foundation RCSB Royal Commonwealth Society for the BlindBRC The British Red Cross Society RMS Royal Mencap SocietyBU Bangor University RNLI The Royal National Lifeboat InstitutionCAF The Charities Aid Foundation ROHCG Royal Opera House Covent Gardens FoundationCCE Church Commissioners for England SA The Salvation ArmyCGL Change Grow Live SAH St Andrew's HealthcareCGLI The City & Guilds of London Institute SCF The Save the Children FundCR Cancer Research UK SU Swansea UniversityCRT Canal & River Trust TLC Trustees of the London Clinic LimitedCU Cardiff University UCSF United Church Schools Foundation LtdGDST The Girls' Day School Trust USW University of South Wales/Prifysgol de CymruLCD Leonard Cheshire Disability WC The Woodard CorporationMC Marie Curie Cancer Care WT Wellcome Trust

Charities taking a lower level of investment risk are exposed to less deficit volatility, and can arguably fund deficits over a longer period of time

Pension scheme analysis

The wellbeing of the pension scheme also provides valuable insights. The charts below show the distributions of funding level and allocations to growth assets.

The average allocation to growth assets has reduced from 60% to 52% over the past 3 years. This has been driven by charities looking to reduce risk within their pension scheme, and reduce the balance sheet volatility & requirements for future cash calls. As the funding positions of charity pension schemes continue to improve, we expect to see this trend continue, with charities & trustees keen to “lock-in” funding level gains over time.

Funding level

Growth asset proportion

BRC

MCCR

CA

FA

TA

QA

RMS

RCSB

SCF

LCD

AC

EBU

RNLI

AG

EBA

RN

HM

HC

RTC

GL

CG

LINT

ROH

CG

TLC

GD

STWC

CU

UC

SFU

SWOIASU

MC

SBC

160%140%120%100%80%60%40%

WT

AFC

SAH

BHF

OX

F

OT

USWBCO

T

OIA

UC

SFC

GL

NH

GD

STC

RTSCF

OX

FSA

HNT

MHATSU

RCSB

RMS

CA

FA

QA

AG

EA

FCWC

LCDCR

MC

BAR

TLC

BRC

MC

S

BUA

CE

90%

60%50%40%30%20%10%0%

RNLI

CG

LI

ROH

CG

CU

BHF

80%70%

Average funding level is 86%

Average allocation to growth assets is 52%

7 charities have a surplus

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1) Expect more regulatory scrutinyThe Pensions Regulator is scrutinising and intervening in scheme funding arrangements more regularly now, after the high profile collapses of Carillion and BHS. This change of approach culminates in a new funding code of practice in 2020, which is expected to have a “comply or explain” regime. This means setting a minimum standard in the code on funding standards, with the onus then being on individual scheme trustees to explain, if required, why it is reasonable in their circumstances to take a different approach. Given the heavy regulatory focus at the moment on dividend levels relative to pension contributions, it will be interesting to see if any sector specific points are in this framework.

2) Use security and contingency planning to support your DB cash costsGiven the resource constraints that many charities have, it’s likely that the minimum funding standards will feel onerous, meaning that the “explain” rather than “comply” option may be more realistic for scheme funding. We're also concerned that setting minimum funding standards may lead to schemes taking more investment risk than they otherwise need to.

A better approach for charities can be to take a lower level of investment risk over a longer period of time in their pension scheme. This narrows the range of funding outcomes, as the charts below show, meaning the scheme places less of a burden on the charity, whilst still recovering over a reasonable timeframe.

This approach needs security or contingency planning to support the longer recovery plan. However, some charities do have unencumbered assets (e.g. property or other investments), which could be used for this purpose. Contingent funding plans can also be used to support this strategy, for example paying more if the funding level falls too far behind plan or if the charity surplus / deficit materially exceeds plan.

How should charities respond?

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 150 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Years from valuation date Years from valuation date

Defi

cit

Surp

lus

Defi

cit

Surp

lus

Higher risk of strategy aiming for fast funding:

Key: Best of estimate time to full funding pushed out

Probability of reaching full funding still strong

Big reduction in volatility and downside risk

Lower risk of strategy aiming for gradual recovery:

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3) Consider DB consolidationAs DB schemes become ever more in run-off, consolidation solutions to reduce costs or management time are being developed in the industry, some of which are particularly relevant to the charity sector.

Commercial consolidators give a clean break from multi-employer schemes at a lower cost than the Section 75 debt

Commercial consolidators give a clean break to employers at a lower cost than buy-out, and could be a good way for charities participating in multi-employer schemes to exit cost effectively.

This solution is really relevant for charities participating in last-man-standing multi-employer schemes. The lack of control over DB funding and risk is often cited as a concern for these charities, but the only way to exit with a clean break historically has been to pay an expensive “Section 75 debt". Bulk transferring to a commercial consolidator gives a clean break at a lower cost than the Section 75 debt. They can also lead to the transferring members reaching the insurance regime far more quickly than if those members were to stay in the scheme.

DB Master Trusts reduce running costs by up to 50%

DB Master Trusts do not give a clean break, but by aggregating DB schemes they can reduce running costs by as much as 50%, helping bridge the pension deficit.

The chart below shows running cost analysis carried out by the DB Master Trust, Citrus.

£m

Pay Section75 debt

Assets

Buy-outLiabilities

S75 debt

Assets

ConsolidatorLiabilities

Premiumpayment

Assets

OngoingLiabilities

Ongoingconts

Stay in thescheme

Transfer to commercialconsolidator

Exit cost is lower than the Section 75 debt

Citrus costs Additional average standalone scheme running costs

500

250

100

20

Num

ber o

f mem

bers

in s

chem

e

Scheme running costs (per annum)£0 £50,000 £100,000 £150,000 £200,000

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Appendix – methodology

1. The charities analysed are the largest 40 by income in England & Wales (as listed by the Charity Commission website) at January 2019 that have DB liabilities disclosed in their accounts. Charities that have no DB exposure (or only account on a cash basis for DB schemes) are excluded. Lloyd’s Register Foundation is also excluded as the charity is the parent of a large trading company.

2. All information has been sourced from the most recently available annual reports and financial statements as published on 1 January 2019.

3. Group / consolidated accounts have been used rather than charity accounts where relevant.

4. Unrestricted reserves and income are considered on the basis that these are potentially available to support or fund the pension scheme. Restricted reserves and income and any endowment funds are excluded on the basis that a pension scheme would not have access to them, other than where the relevant charity accounts explicitly suggest otherwise.

5. Unrestricted reserves are prior to the deduction of any pension deficit.

Please note the value of investments, and income from them, may fall as well as rise. This includes but is not limited to equities, government or corporate bonds, and property, whether held directly or in a pooled or collective investment vehicle. Further, investments in developing or emerging markets may be more volatile and less marketable than in mature markets. Exchange rates may also affect the value of an investment. As a result, an investor may not get back the amount originally invested. Past performance is not necessarily a guide to future performance.

Whilst all reasonable care has been taken in the preparation of this publication no liability is accepted under any circumstances by Hymans Robertson LLP for any loss or damage occurring as a result of reliance on any statement, opinion or any error or omission contained herein. Any statement or opinion expressed reflects our general understanding of current or proposed legislation and regulation, which may change without notice. The content of this document should not be construed as advice and should not be regarded as a substitute for specific advice in relation to the matters addressed. Please note that Hymans Robertson LLP are not qualified to give legal advice and recommend you seek legal advice to consider the matters addressed where relevant.

Hymans Robertson LLP is authorised and regulated by the Financial Conduct Authority and Licensed by the Institute and Faculty of Actuaries for a range of investment business activities. A member of Abelica Global. © Hymans Robertson LLP. Hymans Robertson uses FSC approved paper. 4861/MKT/Inf1216

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6. Net unrestricted income has been considered because this is the amount of income that could be spent on charitable activities or could be used to fund the pension scheme. This therefore excludes any restricted income or endowments, unless the charity accounts indicate that these funds are used to support the pension scheme in which case they are included. This is also net of the costs of generating that unrestricted income. This measure will be crude in some cases, in particular for charities whose charitable activities include running contracts, as the expense to deliver these contracts must be incurred to generate the associated unrestricted income in the first place. In addition, it is a less relevant metric for those charities which are endowment funds, where the size of the endowment is more relevant consideration than the disclosed annual income from that endowment.

7. For charities with a DB surplus, the surplus is shown prior to any balance sheet restriction that is sometimes put in place if the charity does not have a unilateral right to a refund of surplus in their pension scheme rules.

8. DB contributions do include future service contributions (where applicable) as well as deficit contributions.

9. Some charities have significant scheme assets allocated to ‘other.’ In these cases we have tried to allocate these to growth or matching as appropriate using other information in the accounts, but this has required some judgement and may not always be correct.