The Current Financial Climate and Pensions
A Guide for Third Sector Organisations
The Scottish Government believes in encouraging people to save for their retirement. As a Third Sector organisation it is crucial that you are aware of recent changes to pension legislation and accounting requirements and the potential impact on your organisation.
Pension legislation is the responsibility of the UK Government therefore the Scottish Government cannot provide definitive guidance. However, there are a number of organisations who can help you and provide advice and guidance. This guide aims to highlight the changes, consider the impacts and signpost you to the appropriate organisations. It is important that you act now to address pension scheme issues in order to meet the challenges created by a less stable economic environment and continuing regulatory change.
Recent Changes to Pension Legislation
The Pensions Act 2008 introduces a new duty for all employers. From October 2012 all employers will be required to automatically enrol eligible jobholders into a qualifying workplace pension scheme. This means that workers will have to choose to opt out of pension saving, rather than choose to opt in.
Eligible jobholders, (subject to pending legislation), are workers who are working or ordinarily work in Great Britain, who are aged at least 22 but have not yet reached State Pension Age, and who earn more than £7,475 (in 2011/12) this is aligned with the income tax personal allowance.
Employers are free to choose the pension scheme(s) they want to use to fulfil their new duties, provided the scheme(s) meet certain quality criteria. Qualifying schemes may include Defined Benefit, Defined Contribution, Hybrid, stakeholder or Group Personal Pension schemes. Those employers with existing good quality pension provision will be able to continue to use it to meet their new duty if they wish to do so. If they do not, employers will need to make arrangements to choose an alternative qualifying workplace pension scheme.
The National Employment Savings Trust (NEST) will provide a qualifying scheme for those employers who wish to choose it. It is designed to offer low cost pension provision to those on low and moderate earnings.
If an employer chooses a defined contribution scheme they must make a minimum 3% contribution on a band of earnings between the National Insurance Contributions primary threshold (currently £5,715) and £38,185, although they can pay more if they wish. This will be supplemented by the jobholder's own contribution and around 1% in the form of tax relief. Overall contributions must total at least 8%.
To help employers adjust to the new requirements, the plan is to phase in the employer contribution levels between 2012 and 2017: starting at 1 per cent and then moving to 2 per cent and finally 3 per cent in October 2017. The worker's contributions will also be phased in over the same period.
The new duty on employers will be introduced gradually, starting with the largest employers from October 2012, and the smallest employers from 2014. The Pensions Regulator will write individually to employers between 6 and 12 months before their staging date to inform them when they need to take action and what they need to do.
For further details of the changes see The Pensions Regulators website and the Department for Work and Pensions website.
Value of pension funds - Implications for Third Sector Organisations
- Pension scheme deficit/Increased contribution rates
A number of third sector organisations have indicated that their pension schemes have reported significant deficits. This is because the values of scheme assets has fallen at the same time as a combination of increased longevity of scheme members, low interest rates and lower than expected returns have contributed to a rise in the value of scheme liabilities. This results in organisations facing increased costs through the need to increase their pension contributions.
A large proportion of many final salary pension funds are invested in equities and face deficits in periods of significant falls in the value of stock markets. The Pensions Regulator studies pension funds' triennial valuations and can require any employer whose fund is in deficit to take action to rectify the situation.
The Pensions Regulator has published guidance for employers that sponsor pension schemes about the potential problems they may face in funding these schemes in times of economic difficulty.
The Pensions Regulator has published a statement emphasising the importance of prudent funding levels for pension schemes and stating that where sponsors are in difficulty, flexibility is available in recovery plans. What this means is that deficit levels should not be reduced when times are hard, but trustees should consider giving employers a longer period over which to make good any deficit. The statement, 'Scheme funding and the employer covenant - prudence, affordability, applying flexibility through the economic cycle', can be viewed in full on their website.
The statement sets out that while economic and financial conditions have resulted in short-term cash constraints for some employers and greater long-term uncertainty for others, the Pension Regulator's current regulatory framework and approach to scheme funding aims to be flexible.
The purpose of the framework is to secure member benefits for the long-term and to enable employers to play their part in the economic recovery. The approach to scheme funding aims to achieve this with a sufficiently prudent funding target resulting in a recovery plan to repair the deficit in the scheme which is reasonably affordable for the employer.
This statement builds on an earlier communication in February 2009 when the Pensions Regulator issued a statement to employers who sponsor defined benefit pension schemes recognising that economic conditions are of real concern to employers. The statement aimed to reassure employers that the current scheme funding regime is flexible enough to cope with the economic recession. In particular it highlighted that:
- where a sponsor company is under pressure there is potential to renegotiate previously agreed plans to repair pension deficits;
- trustees of pension schemes in deficit are unsecured creditors of their sponsor employer. Trustees should be in a position to understand what is reasonably affordable for their sponsor employers, but all unsecured creditors must be treated equitably and the pension scheme not disadvantaged.
Any employer who believes that an existing recovery plan is at serious risk of jeopardizing the employer's future health or solvency should discuss this with their pension scheme trustees and talk to the Pensions Regulator if they have concerns. The scheme trustee and sponsor employer must inform the Pensions Regulator of proposed revisions to the recovery plan. The Pensions Regulator is looking for outcomes in the best interests of the scheme and sponsor employer.
The Local Government Pension Scheme is not subject to the private sector funding regime although the Managers of each fund have similar obligations to ensure that employer contributions are set so as to "secure the solvency" of the fund, although this is tempered by a requirement to also consider stability of employer contributions (which is typically applied in relation to constitutionally permanent employers rather than admission bodies).
Please note that solvent employers wishing to exit their pension scheme will need to pay the full buy-out debt (this doesn't just apply to employers leaving multi-employer schemes).
Organisations can face high one-off costs if they wish to withdraw from a pension scheme or if an organisation goes into administration it can leave the fund with a substantial deficit.
Changes to the law on private sector multi employer pension schemes were brought in by Statutory Instrument in 2008 ( The Occupational Pension Schemes (Employer Debt and Miscellaneous Amendments) Regulations 2008).
A number of organisations participate in defined benefit multi-employer pension scheme. This may be more viable than each organisation establishing its own scheme. In private sector multi-employer schemes additional liabilities can become payable if an employment-cessation event occurs. An employment-cessation event occurs at the time an employer ceases to employ at least one person who is an active member while at least one other employer continues to employ active members.
However there is a period of grace which is designed to prevent employers with a small number of employees and scheme members from inadvertently triggering a debt when they intend to enroll more members in the scheme. An employer can be treated for a 12 month period as if it employed a person who is an active member of the scheme, if they notify trustees that they intend to employ someone in the next 12 months who will join the scheme. If at the end of the 12 month period the employer still has no active members a cessation event will be deemed to have occurred as at the date that the employer's last active member left.
When an employer ceases to participate in a private sector multi-employer scheme, its share of the liabilities - including any orphan liabilities (benefits in the scheme which are not related to any current sponsoring employer) will be calculated on a "buy-out" basis. This can lead to liabilities (and funding deficits) materially above those which are calculated on the ongoing (statutory funding objective) basis. It may not be necessary to pay this liability in full at the time. It will instead be modified in one of four ways depending on the circumstances, subject to the agreement of the parties involved.
Full details of these arrangements are in the Pensions Regulator's guidance for employers, scheme trustees and advisers " Multi-employer withdrawal arrangements", which can be downloaded from its website.
There is some protection for members if an employer fails - the Pension Protection Fund can pay compensation to members of eligible defined benefit pension schemes, when there is a qualifying insolvency event in relation to the employer and where there are insufficient assets in the pension scheme to cover Pension Protection Fund levels of compensation. Further information about the role of the Pension Protection Fund can be accessed from its website.
Although not subject to the same legislation, employers wishing to leave the Local Government Pension Scheme will also find that the required exit payment is significantly more than the equivalent deficit on the ongoing funding basis. Regulation 34 of the LGPS (Administration) (Scotland) Regulation 2008 provides for a separate valuation to be carried out when an employer's admission agreement ends. Whilst the Regulations do not specify the basis of the calculations, it is common practice for LGPS funds to take a much more conservative approach than they would for the ongoing valuation. Further, as there are no provisions by which organisations with no employee members can continue to contribute to LGPS funds, the exit debt is likely to be levied as a lump sum or spread over a short period.
- Publicly funded contracts
A number of third sector organisations have indicated that local authority contracts do not take into consideration the rising cost of pension provision.
The Joint Statement on the Relationship at Local Level between Government and Third Sector (Scottish Government/Solace/COSLA/SCVO) acknowledges that local authorities must recognise and respect the need for third sector providers to make appropriate provision for operating surpluses and the generation of reasonable and realistic reserves (this would include pensions). Indeed the latest Guidance on the Procurement of Care and Support Services by public bodies in Scotland is very clear and states that the procurement of care and support services should take account of the costs associated with good employment practice (Section 6.32). In this context pension costs are a legitimate expense to be factored into organisations price calculations. Section 7.7 also states that public bodies should take into account the potential costs of staff transfers under the TUPE regulations. The full guidance can be accessed here.
Accounting for pensions
The implementation of FRS17: Retirement Benefits has brought about (for accounting periods beginning on or after 1st January 2005) the balance sheet recognition of pension assets or liabilities for charities that operate defined benefit pension schemes. The nature of this asset or liability is defined by and calculated in accordance with the methods set out in the Financial Reporting Standard.
The accounting requirements of the new standard have focused attention on the health of pension schemes generally. For charities with a defined benefit pension scheme, this in turn can influence the stance taken by those parties with whom a sponsoring charity transacts. In addition, the balance sheet disclosure of pension assets or liabilities has raised questions as to how a charity's reserves policy will be affected.
The Office of the Scottish Charity Regulator recognises that the Charity Commission provides useful guidance on FRS17 at CCFRS17guidance.
The following organisations may be able to offer advice and support. Please note some may charge for their services. All have excellent websites which are a good resource for up to date information on pensions and pension legislation. Your representative or trade body may also be able to offer advice.
The Charity Commission is established by law as the regulator and registrar for charities in England and Wales. The Commission wants to provide the best possible regulation in order to increase charities' efficiency and effectiveness and public confidence and trust. Their website provides a lot of useful and relevant information on the changes to pension legislation, the potential problems facing charities and provides valuable guidance.
- The Department for Work and Pensions
The DWP is the government department responsible for the development of UK pension policy and the law governing UK pension schemes.
The department sponsors a wide range of public bodies to achieve its objectives including the Pensions Regulator.
- The Financial Services Authority
The Financial Services Authority (FSA) is an independent non-governmental organisation responsible for regulating financial services. This includes the regulation of the sale and marketing of personal and stakeholder pensions to individuals.
The FSA also oversees the financial viability of organisations that manage pension investments, and can take action to make sure that the individuals who run financial organisations are fit and proper for the task.
- The Government Actuary's Dept
The Government Actuary's Dept (GAD) advises a number of funded occupational pension schemes in the wider public sector and the private sector, both single- employer and multi-employer pension schemes. Advice is usually provided to the scheme's trustees or managers. GAD also advises some sponsoring employers regarding accounting for pensions costs and other matters.
GAD can help with
- Compliance (including Scheme Actuary) services for defined benefit schemes.
- Consulting services for trustees and managers.
- Advice to sponsors of pension arrangements.
- Scheme design and reviews.
- Accounting for pension costs.
- Strategic investment reviews.
- NEST (National Employment Savings Trust).
NEST will be a new workplace pension scheme that's being designed specifically to meet the needs of low-to-moderate earners and their employers.
NEST is the new low cost pension scheme any employer can use to meet new legal duties that start to be introduced from October 2012.
It will operate as a trust-based occupational pension scheme run by NEST Corporation, a trustee body that puts scheme members first.
- The Office of the Scottish Charity Regulator (OSCR)
OSCR formally took up its powers under the Charities and Trustees Investment (Scotland) Act 2005 and wants to see a flourishing charity sector in which the public has confidence, underpinned by OSCR's effective delivery of its regulatory role.
OSCR were set up to:
- Increase public confidence in charities through effective regulation.
- Increase transparency and public accountability of charities.
- Increase charity trustees' compliance with the 2005 Act.
- Establish and maintain OSCR as a trusted, effective and innovative regulator.
- Minimise the burden of regulation on charities wherever possible, with particular emphasis on reducing multiple reporting.
- Operate effectively and efficiently, demonstrating a commitment to the principles and practice of Best Value.
- The Pension Protection Fund
The Pension Protection Fund was established to pay compensation to members of eligible defined benefit pension schemes, when there is a qualifying insolvency event in relation to the employer and where there are insufficient assets in the pension scheme to cover Pension Protection Fund levels of compensation.
The Pensions Regulator (PR) is the UK regulator of work-based pensions. The Pensions Act 2004 gives PR three main statutory objectives:
- to protect the benefits of members of work-based pension schemes;
- to promote good administration of work-based pension schemes; and
- to reduce the risk of situations arising that may lead to claims for compensation from the Pension Protection Fund.
In order to meet these objectives, PR concentrates resources on schemes where they have identified the greatest risk to the security of members' benefits.
The Pensions Act 2008 will give PR a new objective to maximise compliance with the new employer duties, as well as two new safeguards to protect employees who want to save in a pension. PR is currently developing their approach to making sure employers comply with their new duties.