The Pensions Regulator has issued new guidance on assessing and monitoring the employer covenant supporting defined benefit pension schemes.
It contains specific information for charities participating in such schemes. The guidance is available here.
The employer covenant to a scheme is the extent of an employer’s legal obligations and its financial ability to support that scheme now and in the future. The pension scheme trustees’ view of the covenant underpins their approach to investment and funding.
The guidance reflects the principle that employers and trustees should work collaboratively to reach funding solutions that recognise the scheme’s needs and the employer’s plans for sustainable growth. For charities, sustainable growth can mean enabling expenditure on developing fundraising channels, expanding charitable operations or simply remaining viable. Trustees should have a documented process for monitoring the employer covenant. The guidance contains a number of examples and checklists to help with this.
What do trustees need to do?
Broadly, trustees of defined benefit schemes sponsored by charities should:
- understand the legal status of the charity, as this has implications for its ability to support the scheme on an ongoing basis and in insolvency (the Charity Commission’s guidance for charities facing financial difficulties, available here, is useful for this);
- understand the extent and nature of any restrictions on the income, assets or reserves, as restricted funds may not be able to be used to fund the scheme; and
- when assessing the charity’s income streams and their likely trends over time, donation income should be analysed as distinct to income from commercial activities (such as income derived from contracts or fee-paying service users).
How should different types of funds and income be treated?
If restricted funds form a material part of a charity’s covenant, trustees should consider obtaining legal advice on whether those funds (or income from them) can be used to support contributions to the scheme. For example, restricted funds may sometimes be used to fund the scheme where scheme members are working on projects that involve restricted funds.
Donation income tends to be more volatile than income from commercial activities, but the related expenditure is often discretionary and could be reduced if donation income declined without affecting the affordability of pension contributions. If donations are a material part of a charity’s covenant, trustees should monitor these on an ongoing basis.
A balance needs to be struck in relation to the level of pension contributions as a proportion of donation income. The Pensions Regulator notes that taking a high proportion of donations as contributions may reduce the likelihood of future donor support. However insufficient funding of the scheme may require it to take greater investment risk. Poor investment outcomes could increase the scheme’s deficit to a point where it creates difficulties for the charity and undermines donor support.
The Pensions Regulator is planning further guidance to help with integrated risk management and investment strategy. In the meantime, charities and pension scheme trustees should look at the flexibilities they have to put in place funding solutions tailored to their specific circumstances.
For more information on pension scheme funding for charities, please contact Christopher Nuttall on 01604 463134 or click here to email.