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Charities and Scottish Independence

Top Five Pension Issues for Charities and their Pension Scheme TrusteesThe referendum on Scottish independence will be held on 18 September. Independence will follow just 18 months after a yes vote. Top Five Pension Issues for Charities and their Pension Scheme Trustees

The referendum on Scottish independence will be held on 18 September. Independence will follow just 18 months after a yes vote. Independence will create a number of pension headaches. Charities and their scheme trustees should be thinking now about what they may need to do. There may not be enough time if everything is left until the day after a yes vote.

Here are my top five pension challenges.

1.  Make sure you avoid creating a cross-border scheme

The Scottish Government believes that Scotland will be admitted to the EU on independence. This will immediately create difficulties for charities providing benefits under their UK final salary schemes to employees in England and Scotland. Schemes applying to employees in two EU countries must be fully funded at all times. Most UK schemes fall well short of full funding. There is a two year transitional period for compliance for new schemes. But existing schemes must comply immediately.

So charities will have to provide additional funding or immediately close their scheme to employees on one side of the border or the other after independence.

Few employers can afford to tip in the additional funding needed for immediate compliance. None will want unpredictable cash calls to top up their scheme when the funding level falls.

The Scottish Government proposes discussions with the UK Government and the European Commission on the application of these requirements and possible transitional arrangements, but it would be a brave employer that would await the outcome of the discussions, which might only be known close to independence itself.

If you are affected, the alternative is to close your scheme to Scottish (or non-Scottish) employees and put them in a new scheme (or use it as the occasion for a more fundamental review of your pension provision).

If you set up a new scheme, this will raise a number of important issues:

  • Will you demerge your existing scheme so that accrued benefits for Scottish and UK employees will be allocated to the relevant scheme?

  • What actuarial basis will you use to split the corresponding assets?

  • Do you have illiquid assets and/or special funding structures and guarantees which are not easy to split?

  • Will one of the employers in your current scheme cease to employ any active members, triggering an immediate funding requirement (the "section 75 debt")? How will this be managed?

  • Will the loss of economies of scale in investment and administration and possible changes in the employers supporting the schemes lead to a higher contribution rate?

  • Will different funding assumptions (for example, on salary and price inflation, life expectancy etc) be appropriate for the schemes to reflect membership profile and economic conditions in separate countries?


Demerger and funding issues have long lead in times. Early planning is the key to finding effective solutions.

2.  Consider how the restructure of schemes for non-associated employers will affect you

If you participate in a multi-employer scheme for non-associated employers, your scheme will be faced with the same challenges in avoiding becoming a cross-border scheme as highlighted above. The crucial difference is that you will have much less influence in how the problem is addressed. Critical decisions in these multi-employer schemes tend to be taken by the scheme trustee. Employers may be consulted but, unless there is an active employer consultative committee, their ability to influence proposals is limited.

I expect these schemes to be just as anxious as other schemes to avoid the funding implications of becoming cross-border schemes. This will mean charities being asked to remove their Scottish employees from scheme membership. Charities which only have Scottish employees will have to cease to participate altogether. This will have potentially disastrous financial implications because a charity that ceases to participate has to pay the whole buy out funding deficit attributable to its current and former employees.

Will the scheme providers set up Scottish mirror image schemes for these Scottish charities and transfer the benefits for their current and former employees to the new scheme? This would be attractive for the providers, who will not want to lose the charities' business, and will significantly reduce (but not eliminate) the funding issue.

For some charities, it may even make sense to set up their own Scottish scheme to receive the transfer and take greater control over the management of pension funding going forward.

Charities that don't want to be at the mercy of the scheme providers will need to be proactive in the development of solutions.

3.  Review the implications of changes in the source of funding for your employer covenant

The employer covenant, its ability to support its pension scheme, is critical to scheme trustees' decisions on funding assumptions and the level of contributions required. Scheme trustees should already be thinking about how independence could impact the financial strength of their sponsor charity as part of their covenant monitoring duties. They should be factoring it into current valuations.

In particular, scheme trustees should be considering how independence will affect your sources of funding? To what extent is funding derived from central government or UK grant making bodies or other UK charities? Will those roles be taken over by equivalent Scottish agencies?

Charities like Cancer Research UK, the British Heart Foundation and the Wellcome Trust spend more than £140m a year in Scotland on medical research. The UK Government spent £21m in 2012 on medical research with Scottish institutions. Will that level of grant funding be maintained or replaced after independence?

Some charities may have restrictions on endowed funds being used outside the UK. Their covenant as an employer for a Scottish pension scheme may be lower than for their UK one.

How will the level of funding from corporate and public donors be affected? Will UK donors be less inclined to donate to charities associated with Scotland?

4.  Review your ABC arrangements

It is still comparatively rare for charities to have put in place the more complex Asset Backed Contribution structures which involve the use of Scottish Limited Partnerships (SLPs). These structures involve employer assets, such as property, being placed in an SLP in which the pension scheme buys a partnership share entitling it to an income stream provided by the underlying asset. The arrangement gives the scheme security that future contributions will be paid.

SLPs are used because, by a quirk in the relevant legislation, SLPs are not caught by the restrictions on schemes making employer related investments, but only because Scotland is part of the UK. If it becomes independent, the employer related investment restrictions will apply to SLPs. It will then be a criminal offence for trustees to invest more than 5% of their scheme's assets in SLPs and other employer related investments.

Will there be transitional regulations to provide a period of grace to unwind existing arrangements and achieve compliance? This must be doubtful. It is not HMRC practice to amend the law to enable unintended loopholes to continue to be used.

Employers and schemes with ABCs should be looking at their arrangements to see how they could be unwound or restructured in the event of Scottish independence and how this would affect scheme funding.

5.  Will auto-enrolment be affected?

Most charities will have had to comply with the auto-enrolment requirements by the time of independence. The Scottish Government has indicated that it will continue with the roll out of auto-enrolment after independence. So what will the differences be?

In time the Scottish Government may decide on a different level of minimum contributions, but no changes are contemplated at the moment.

The Scottish Government also wants to preserve access to the UK National Employment Savings Trust (NEST), at least for all employees in Scotland currently contributing to it. It is also proposing to set up a Scottish equivalent to NEST. It remains to be seen whether the UK Government will allow contributions to NEST from a newly independent Scotland. Indeed, the Scottish Government may have an interest in preventing new employees contributing to the UK NEST if it wants to help the Scottish equivalent achieve critical mass.

Conclusion

Don't find yourself thinking about these issues for the first time on 19 September. Structural changes to pension arrangements require advance planning. The UK Government is apparently not laying the ground work in case of a "yes" vote. But that is no reason why you should do the same.

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