UK charities should take a leaf from Royal Mail's book. A number of them may find themselves in very similar circumstances, says Spence & Partners' David Davison.

At the end of March, the EU approved plans to allow the UK government to provide the Royal Mail Group (RMG) with financial support relating to "excessive pension costs", as well as restructuring aid consisting of a debt reduction amounting to around £1.1bn (€1.4bn) in total.

While the state owned RMG had a monopoly over certain letter services until the market was opened in 2005, the government effectively accepted that the pension accrued prior to this date was the responsibility of the state and represented an unreasonable burden on the organisation, as it would impact on its future competitiveness and limit privatisation options.

As a result, the government intends to transfer around £37.5bn from the Royal Mail Pension Plan to a newly established, unfunded public pension scheme. The move will result in a windfall to the Treasury, with around £28bn of assets also being transferred.

What is not widely understood is that the RMG scenario is not unique, with very similar circumstances affecting numerous leading UK charities. As the drive for public sector services outsourcing has gathered pace over the last decade or so, many charities in the education, leisure and housing sectors, to name but a few, were established to assume responsibility for these services. As part of that process, these organisations also took on responsibility for staff pension provision, frequently unaware of the wide-ranging and potentially devastating implications of such a move. One organisation I have advised, established in 2007, had around £20m of pension liabilities, of which around £15m related to benefits accrued prior to its formation.

Within local government pension schemes, they are unable - or possibly unwilling - to split the liabilities between relevant employers, usually recognising the last employer as having responsibility for the full liabilities. Frequently, on transfer, the local government schemes will make the assumption that the liabilities are 100% funded on an ongoing basis.

This is, however, far from a cost-neutral position for many of the organisations affected, leaving them completely exposed to market movements and changes in future assumptions. Where asset values have fallen or not kept pace with assumptions, or where the value of liabilities has increased - such as to account for lengthening longevity - this will result in increased deficits and therefore increased contributions. The new employer will be responsible for all of these increased costs, not just those that relate to their period in existence, with such an increase unlikely to be reflected in their council funding. These costs must therefore somehow get absorbed within their current budgets.

Should the organisation wish to consider exiting the scheme again, it will be responsible for all liabilities, with the costs considerably in excess of those identified on an ongoing basis. In the case of the organisation highlighted above, the exit cost relating to its period in existence was around £3m, which might have been affordable. The total exit cost of around £12m relating to all service, however, was not. Organisations are forced to pay this increased cost even though the ultimate benefits will not actually be secured, a double benefit for the local authority.

The transition has also left organisations exposed to substantial ancillary costs. Should individuals be forced to retire on ill health or made redundant, this will result in a strain on fund charge payable by the employer, based on the total period of service. It is not uncommon for these costs to amount to more than £100,000, a very significant sum for which the organisations, rather than local authorities, are fully liable.

As part of the transition some local authorities provided supporting guarantees, but these seldom deal with any of the issues identified above and therefore provide little comfort. We also now have the ridiculous situation where some newly formed outsourcing organisations that were forced to provide access to local government pensions schemes are being rejected on re-tendering, as the pension costs make them uncompetitive and disadvantage them against organisations with lower-cost pension provision.

Local authorities have effectively dumped millions of pounds of their pension liabilities and a huge level of associated risk on some unfortunate and unsuspecting charities. There is now a pressing need for these schemes to identify the responsibility for periods of service and apportion costs proportionately. There also needs to be a fundamental review of the existing legislation to allow organisations to exit schemes on a more viable basis.

Some of the affected organisations should consider pursuing a collective legal case - on a similar basis as RMG - to ensure the historical position was dealt with fairly. The acceptance of responsibility for prior pension debt is not just one affecting the Royal Mail. Any new organisations being formed to provide outsourced services need to be very clear about their pension liabilities.
David Davison is head of public sector, charity and not-for-profit practice at Spence & Partners