Credit unions’ pension conundrum

Around 130 credit unions in Ireland participate in a multi-employer defined benefit pension scheme with some 2,000 members. The scheme is in deficit by €94m and the trustees recently decided to close the scheme to further accrual.

This means that employees keep the benefits they have earned to date but cease to earn further ones. Credit unions will provide a defined contribution scheme for all future members.

The current deficit will be paid for by each credit union based on the number of employees, both past and present, who were in the pension scheme.

Orphan allocation

Each credit union will also be allocated a portion of ‘orphan’ scheme members, who either worked for a credit union that no longer exists or one that exited the scheme.

For some credit unions, the bill will stress their reserves to the limit. However, savings will never be at risk, given that all savings up to €100,000 are government guaranteed. In addition, the movement has a mutual protection fund can be accessed by credit unions that are approaching the 10% reserves limit.

It should also be noted that €80.9m of the mutual protection fund is planned to be returned this year to credit unions as a one-off dividend. Even without this, nearly all credit unions are in a position to absorb the payment.

Defined contribution accounting

Credit unions were offered a choice to discharge their share of the deficit with cash up front or deferred payment over 10 years. Both options will incur a wages expense in the current year for the full amount.

For both options, the accounting is simply Cr bank and Dr wages expense. If payment is deferred there will be an additional interest charge each year.

The deferred option requires that the credit union discount the payments ‘by reference to market yields at the reporting date on high quality corporate bonds’. These will give a cost that is booked immediately as an expense (Dr wages expense and Cr pension liability), and the payments over 10 years will be split as capital and interest.

The 10-year spreading option includes an interest charge element but that may not be the same as the rate on ‘high quality corporate bonds’, so it may not necessarily be a simple exercise of amortising the additional interest element.

However, the interest charged for spreading the payment does look to approximate to high quality corporate bond rates, and most credit unions that choose the 10-year deferral will probably simply amortise the interest as charged.

Defined benefit accounting

A multi-employer defined benefit scheme can be accounted for as a defined contribution scheme ‘if sufficient information is not available to use defined benefit accounting’. The multi-employer scheme is currently accounted for as a defined contribution scheme.

Some argue that there is sufficient information now available to allocate the deficit, and therefore defined benefit accounting should be used. However, the information now available is not the precise information as required by an accounting standard that did not anticipate the concept of 'orphan' pension fund members.

Defined benefit accounting will produce a different deficit figure as it is calculated based on different prescribed assumptions. It will also introduce greater volatility as these assumptions may change more quickly than the more long-term view and triannual calculations provided by an actuary.

How to choose

A credit union must hold 10% of its assets in reserves, so discharging the pension liability up front will actually reduce the amount that it needs to maintain. The interest charged to defer is also more than the return credit unions gain on investments. On the face of it, paying up front looks to be the best option.

However, some credit unions may decide to defer payment and then end up being unable or unwilling to pay. Also, a steep increase in interest rates could turn a current deficit into a surplus quite quickly.

Some credit unions may refuse to pay their share of a deficit that no longer exists. Some may also be liquidated or resolved in the intervening 10 years. If payment is not enforced or is unenforceable, then those that paid upfront will be disadvantaged.

The debts of a credit union in liquidation/resolution are discharged in the same order as for a company, so pensions liabilities will be preferential creditors and paid in advance of a refund of any members savings. Members' savings are state guaranteed so they will be paid even if there is an overall deficit.

However, it is unclear if pension fund trustees – notwithstanding that they are legally entitled to do so – will actually force an individual credit union all the way into liquidation/resolution to collect their contributions.

Exiting the scheme

There is an option for a credit union to exit the pension fund altogether, which will cost more than double the current funding call. Given that interest rates are at historic lows, annuity rates are at historic highs and returns lower than normal, many argue that pension liabilities are at their peak just now.

Exiting will remove the pension liability – both current and future – from the balance sheet. However, it may be imprudent to do so when it would appear that the liability is at its peak and the exit cost is expected to drift downwards over the next few years as interest rates increase.