In its annual report on DB pension funding in the charitable sector, the leading pensions and financial services consultancy found that charities could significantly reduce their pension cash contributions by pledging security to support a lower funding target or longer recovery plan.
The report also found that the proposed new TPR funding regime will see pension deficits for the largest 40 charities in England & Wales increase overall by a substantial £1bn to £3.5bn, as schemes are required to put in place long term funding targets.
Commenting on how charities could benefit from using the bespoke rather than fast track option under the proposed new DB funding regime, Alistair Russell-Smith, Head of Corporate DB, Hymans Robertson, says: “The new DB funding regime is coming into force in 2022/23 and charities have big decisions to make as a result. 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. Charities are, therefore, more exposed to increased cash requirements under the new funding regime than other sectors.
“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 whilst keeping cash contributions at current or even lower levels.
“It has been a tough year for charities with fundraising and retail income plummeting while, simultaneously, demands for their services have led to increased pressure on expenditure. Cash to fund the pension scheme is therefore scarce. However, some charities do have significant balance sheets and unencumbered assets, which can be used to support the pension scheme and reduce cash costs. 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 35-65 per cent. 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.”
Hymans Robertson’s report explains how the reduction in cash contributions for a scheme taking the bespoke route has been calculated using the example of a charity that has a £100m DB scheme that is 90 per cent funded on Technical Provisions (the average funding level for UK DB schemes). They have assumed that the Fast Track option requires this charity pension scheme to be fully funded on a gilts + 0.5% Long Term Objective (LTO) within 15 years, with a cash recovery plan of no more than 6 years.
However, using the Bespoke approach enables adoption of a lower gilts + 0.8% LTO, with £16m of security bridging the gap between this lower funding target and the equivalent Fast Track LTO. Pledging further security can then also support a longer cash recovery plan than 6 years, thereby further lowering the annual cash costs.
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