From Ros Altmann:economist and pensions,
    investment and retirement policy expert

  • pensionsandsavings.com

    Toys’R’Us is another signal for Government to recognise dangers lurking in UK pension schemes

    Toys’R’Us is another signal for Government to recognise dangers lurking in UK pension schemes

    • Toys’R’Us pension woes highlight risks in employer pension promises
    • Most private companies cannot shoulder open-ended multi-decade liabilities
    • In coming years, more employers will look to offload their pension schemes – or be bankrupted by them

    Toys’R’Us is the latest casualty in the UK defined benefit pension crisis, highlighting yet again that private sector employer pension promises cannot always be relied upon. The Government recently concluded that most employers can afford their pension deficits, but I believe this is too complacent.

    The fall in interest rates following the Bank of England’s Quantitative Easing policy has damaged UK pension funds and led to significantly increased deficits. Many employers have had to put huge sums into their final salary-type schemes to address these shortfalls, but it is unrealistic to expect private companies to underwrite ever-increasing open-ended long-term liabilities for many decades into the future, especially as the schemes are closed and therefore the employer will have no ongoing interest in underwriting the risks.

    Of course, its pension obligations are not the only problem for Toys’R’Us. It has suffered years of losses, partly due to on-line competition, structural demand shifts in retail shopping and a highly indebted balance sheet. However, the ballooning pension deficit may be the straw that breaks the company’s back. The pension scheme reported an £18.4million deficit in January (up from £10.25m the previous year) and the company does not have the funds to meet this, which could leave the company’s fate in the hands of the UK Pension Protection Fund (PPF). This protects all pension scheme members.

    The PPF ensures members will receive most of their promised pensions, but it only pays out around 80%, rather than the full amount.

    The PPF itself has to protect against companies unfairly underfunding their pension schemes and then trying to walk away, leaving the PPF to cover any shortfall.

    It is important to prevent such ‘gaming’ of the PPF, because this is an insurance system which is funded by all other employers running final salary-type pension schemes. If unscrupulous companies try to short-change their pension schemes, then the burden falls on other companies. That is why the PPF and the Regulator are asking for more money, in order to agree to the proposed restructuring which Toys’R’Us would like.

    Normally, if a company wants to relinquish responsibility for its pension scheme, it must pay in sufficient funds to guarantee all pension payments in full, but that would be even more expensive than the £18.4million reported deficit, as it would require annuity purchase.

    But if the business faces insolvency, the Regulator and PPF can agree to accept different arrangements for the pension fund. However, they will not want other unsecured creditors to be given priority over the pension members.

    The Regulator is also obliged to look into the corporate history, to see whether the management of the firm has treated the pension fund fairly in the past. If it is considered to have deliberately underfunded the scheme, the Regulator has powers to require additional payments. The situation is not as clear-cut as BHS, but there may be similarities.

    The Work and Pensions Select Committee has also looked at this situation and expressed serious reservations about past financial transactions. For example, it has questioned the write-off of £585million in loans to a BVI related company last year and it has also queried the tripling in salary paid to senior management, despite the company having made losses for the past few years.

    There will be a tussle between the various creditors and it is not clear who has more power. The company wants to lay off one quarter of its staff and close 26 of its 84 UK stores. If the PPF does not agree to this, then the firm may face bankruptcy which puts 3200 jobs at risk.

    The owners do not want administration, since this will destroy more value and they therefore have an incentive to try to find more money to satisfy the PPF’s demands. But they say they simply cannot afford the £9million being demanded. Meanwhile, the PPF has to decide how far it can push for more money. It will be mindful of the loss of more jobs, but also must assess whether the pension scheme might achieve a better outcome from a CVA or from insolvency. It could also be considering using its powers to chase connected companies to pay in more.

    It is clear that the current economic and interest rate environment have both dealt a hammer blow to Toys’R’Us, with the pension fund being damaged in the process. It is a worrying time for the workforce and, unfortunately, this will not be the last company to suffer in this way. With schemes almost all closed, more employers will be looking for ways to offload their pension schemes. Sponsors will want to rid themselves of their pension responsibilities, which are just legacy risks with no business rationale. In the face of Brexit uncertainty and sectoral declines, the Government and Regulator must not be complacent.

    Urgent work is needed to plan the ‘end-game’ for these schemes, rather than assuming most employers can afford their liabilities. The authorities should plan how best to address the weakness in UK schemes, for example by encouraging consolidation, streamlining of benefits, cost-cutting and professionalisation so the liabilities can be managed more successfully in the decades to come.

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