PENSIONSANDSAVINGS.COM

8th January 2015

•  Tesco to close its Pension Scheme – won’t reduce deficit near term but every little helps!
  
• Rising pension deficit and cost reduction pressures force closure of last FTSE100 final salary scheme
  
• Artificially depressed bond yields contribute to pension losses for thousands of staff
  

Tesco has announced, as expected, a consultation to close its pension scheme – one of the last remaining open defined benefit schemes in the private sector.  Among a string of cost-cutting measures, the company is likely to move its staff onto less generous defined contribution pensions, but the firm says it does not expect this to damage its ability to attract workers as many do not value the long-term benefits of a guaranteed pension.

With the latest sharp fall in gilt yields, it is expected that Tesco’s pension deficit will have increased significantly, even beyond the £3.4bn pension fund shortfall it reported in August 2014.  At that time, the company said that the pension scheme’s £8bn of assets (up from around £6bn in 2012), had not increased by as much as the rise in its liabilities, which reached more than £11bn as bond yields plunged.

The scheme is one of the country’s largest, with 170,000 members, but as the company has had a rough year and its long-term security seems less assured, the pressure to stop accruing significant additional open-ended liabilities had become irresistible.

Tesco has hitherto been committed to providing excellent pensions for its staff and has tried hard to retain the generous defined benefit promise.  It has made strenuous efforts the keep the scheme open, while making some adjustments in recent years that would reduce its costs somewhat.  In 2012, it started its own in-house investment operation to cut the costs of managing its fund, increased scheme pension age for future service by two years and reduced the inflation linking from rpi to cpi, but it retained a cap of 5% even though the law only requires up to 2.5% inflation protection.  However, these changes are relatively minor compared to most other private sector schemes and, by also pledging property assets to the pension trustees, there has been a clear willingness to support the pension fund.

Unfortunately, Tesco’s troubled business performance and the general uncertainty around interest rates has increased the pressure on management to find ways to cut costs further and the closure of its pension scheme was widely anticipated.

Will closing the scheme solve Tesco’s pension deficit problem?  Certainly not in the short-term.  The rising deficit is due in large measure to the sharp fall in bond yields.  Scheme closure only applies to future benefits, not to pensions already accrued.  Continued falls in bond yields will lead to further deficit increases even if the scheme closes.  In addition, with a large deficit, trustees may demand much higher contributions more quickly, because the flow of member contributions may reduce.  They will also be concerned, in light of the weaker financial performance of Tesco this year, that the sponsor covenant is weakened.  The pension deficit would also have hindered the company’s ability to pay shareholders large dividends  as company resources have to be shared with the pension scheme, so the dividend pass is consistent with the pension deficit and avoids potential conflict with the Pensions Regulator and trustees.

With long bond yields sinking to unprecedented lows, pension deficits have risen across the the UK, as the liabilities increase by more than assets when rates decline. Buying gilts or bonds is not a solution either.  Many schemes have switched assets into bonds and received additional employer contributions, but their deficits have keep rising,  The lower bond yields fall, the worse the deficits become and closing the scheme will not prevent further deterioration.

The following chart indicates just how far away from historic norms the yields levels on long gilts have moved.  This has been aggravated by Bank of England buying and further pension fund purchases of gilts, in an effort to reduce the risk of further deficit increases.

Chart of 40 year UK Gilt price – 4¼ %Treasury 2055: 2005-2014

 

Long gilt yields are in uncharted territory.  Ironically, the aim of official gilt purchases has been to revive the economy.  The effectiveness of this policy may be questioned firstly because the UK is generally much more sensitive to short rates than long rates and secondly, if the fall in long yields forces major firms like Tesco to divert resources away from their businesses and into their pension schemes in the near term, the pension impacts weaken the economy.

The closure of the Tesco scheme will be another pension casualty of policies aimed at stimulating the economy.  In the short-term it won’t solve the firm’s pension deficit, but it may alleviate some of the pressure – every little helps!  Of course, in the long-run, pensioners will be poorer as a result.

Scheme closure may have been inevitable as 21^st century private companies cannot safely be relied upon to underwrite liabilities for fifty years or more, but I do believe that the effects of low bond yields on pensions have been significantly underestimated so far.  By the time they are properly recognised, it will be too late for many.