Britain's charities are facing a pensions crisis

What's going on?

Britain's charity sector faces a looming pensions crisis, as many struggle to square their growing liabilities to pension-scheme members with falling fund values and shrinking incomes. Northern Irish charity Spirit of Enniskillen set up in 1989 after the IRA bombing is being wound up after its liabilities overwhelmed it recently. And last December another small charity, People Can, went under because its deficit jumped from £11m to £17m, while the value of its main asset, a Liverpool arts centre, fell to £6m.

A Sunday Times investigation puts the combined deficit of 16 big charities at £400m. "This is just the tip of the iceberg," says pensions consultant John Ralfe. "The private sector began tackling its pension problems a decade ago, but charities, like others in the quasi-public sector, have been very slow to respond."

What's the problem with their pensions?

Charities face the same problems as companies when it comes to funding final-salary schemes an ageing population, unsustainable legacy costs, years of low returns from equity and bond markets, and so on. However, those difficulties are exacerbated by other factors.

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Whereas some struggling businesses have buckled under the burden of unsustainable pensions, others have survived by transferring physical assets (such as a factory or office building) to the pension scheme, borrowing from lenders, or asking shareholders for new capital. These options aren't available to charities. Other factors, too, make them vulnerable.

Why are they vulnerable?

Charities have typically been several years behind the private sector in cutting final-salary schemes, partly as they are often competing for staff with public-sector organisations offering generous defined-benefit pensions. Many charity schemes also kept more of their assets invested for long-term growth than the private sector. A decade of stock market underperformance has led to significant deficits. Plus many charities signed up to multi-employer defined-benefit schemes' when defined pensions were a common employee benefit.

According to the Charity Finance Group (CFG), 4,000-5,000 mainly larger charities are in these schemes. The legislation underpinning the schemes was designed to stop private companies restructuring and abandoning their liabilities. For charities, the rationale was that organisations especially small ones could share the risks and costs of running a scheme. In practice, say charities, it has led to increased costs and risks.

Why did costs and risks soar?

The structure of the mutual obligations risks creating a domino effect of collapses. An employer that leaves a multi-employer scheme is liable to pay a statutory section 75 debt' to the scheme, calculated on the insurance buy-out basis potentially a huge liability. This creates a double-bind: if they leave they trigger an unaffordable section 75 debt, but if they remain they build up further liabilities. Worse still, many charities joined last man standing schemes', where unpaid orphan' liabilities pass to the remaining members.

For charities, that's not only financially ruinous, but it's also a PR disaster. As Amnesty International's finance director Iain McSeveny puts it: "Our supporters give us money to fight human rights abuses, not fund the deficits of other charities' pension schemes."

What are charities doing about this?

Barnado's announced the closure of its final-salary scheme after its deficit rose from £73m to £84m. The NSPCC, which runs the 24-hour phone service ChildLine, closed its own scheme in 2009, and has insured a big chunk of its pension liabilities with specialist provider Pension Insurance. The charity transfers £63m in assets to the insurer, which then assumes key risks in the scheme, including for inflation and rises in longevity. Cancer Research UK has made a similar provision. Meanwhile, the CFG is lobbying the government to ease rules on multi-employer schemes and letting charities borrow to plug pension holes.

Will charities survive?

Charities do have some advantages, says Patrick Bloomfield, partner at actuary Hymans Robertson: they are often debt-free and with cash reserves giving them breathing space. "Charities' pension funds all benefit together or all struggle together." Although failures have so far been tiny, "each one adds a painful bit of marginal cost". The risk that some charities won't cope, says Bloomfield, puts "vital charity work at risk", to the detriment of the vulnerable in society who "suffer most when the economy is struggling".

How big is the charity sector?

According to Charity Commission figures, there are more than 160,000 registered charities in Britain, employing a total of 857,000 people about 3% of the workforce. Charities spend about £17.7bn a year on goods and services roughly the same as the NHS. Most are tiny: 40% generate an annual income of less than £10,000; only 15% make more than £500,000. Just 1% of charities generate income of more than £5m.

Last year, the amount donated fell from £11bn to £9.3bn, the lowest since the financial crisis. However, only a fifth of charities' income comes from individual contributions from the public. The bigger and better-known charities typically generate income from sources including commercial activities, government grants, providing services to local authorities, sponsorship and lottery funding.