Royal Mail Group has begun consulting with active members on closing its section of the Royal Mail Pension Plan, spurring the threat of industrial action from unions if the sponsor does not react positively to their concerns.
The scheme already sparked strikes last year after trustees agreed to the closure of its Post Office section.
Royal Mail pledged that its ongoing pension spending, currently standing at £400m in cash contributions, will not be reduced under any new defined contribution arrangement.
If you’ve already got a safety net in the PPF, why aren’t you out doing your stuff on the trapeze? They’re doing their tricks half an inch off the ground
Henry Tapper, First Actuarial
At first glance the £7.55bn pension fund appears to be in good financial health, boasting a surplus of £1.2bn in the Royal Mail section at its last funding update in March 2014.
The surplus was in part created by the transferral of liabilities accrued before 2012 to the coalition government under the Royal Mail Statutory Pension Scheme, as part of the controversial decision to privatise Royal Mail.
In 2018 that surplus would run out, according to the group’s financial review, with the company’s contributions rising from 17 per cent of pensionable pay to 50 per cent, or more than £1bn a year.
In a statement, the company explained: “This increase would not be affordable. It is significantly more than the annual cash Royal Mail generates – around £290m in 2015-16.”
Changes to Royal Mail staff’s pension provision would not be implemented before 2018, but the consultation proposed that unless an “affordable alternative” is found, the defined benefit arrangement will be replaced by a DC scheme in April of that year.
The consultation period ends on March 10 2017, after which the company said it will discuss member feedback with unions.
Strike on the cards
Union Unite and the Communication Workers Union both refused to rule out industrial action, with the CWU stating that it will ballot members on strikes if Royal Mail closes the scheme without the union’s agreement.
Brian Scott, Unite officer for the Royal Mail, called for the group to “react positively” to the union’s concerns, and said DB provision was still the target.
“We are looking to retain any final salary link and will look at all options that may be available,” he said.
Despite Royal Mail’s pledge to contribute to a new arrangement at the same level, members will see a worsening of their retirement outcomes, explained Hugh Nolan, director at consultancy Spence and Partners and president of the Society of Pensions Professionals.
“They’re using that surplus to keep the contribution level down, so they should be paying a billion now,” he said.
A familiar story
Nolan said that replacing DB with DC was an uncomfortable reality in today’s world, and outlined continuation of schemes that dwarf their sponsors as “putting your entire business at risk and the future of people’s jobs”.
He added that even government would have to address the inequality between public sector DB schemes and private sector DC offerings, and noted the relative strength of Royal Mail’s proposal.
“A typical DC scheme employer might only be paying in 6 per cent, so for an employer to say, ‘We’ll still pay in 17 per cent’, that’s not a bad deal,” he said.
Returning to the DB debate
Of course, those who believe that the prevailing mark-to-market valuation methodologies do not accurately reflect the ability of schemes to pay pensions view the decline of DB as an avoidable phenomenon.
Henry Tapper, director at consultancy First Actuarial, took issue with the scheme's heavy weighting towards fixed income, saying that investment decision could be argued to be “reckless conservatism”, which has threatened the employer’s solvency.
“If you’ve already got a safety net [in the PPF] why aren’t you out doing your stuff on the trapeze?” he asked. “They’re doing their tricks half an inch off the ground.”
The first three months of First Actuarial’s FAB index found the UK’s DB funding ratio to be 126 per cent at the end of November, using a best estimate methodology that discounts liabilities based on the expected return of the scheme’s assets rather than the yield on bonds.
Schemes such as Royal Mail’s cannot simply upgrade their return expectations without changing their asset mix. But Tapper argued that the adoption of a best estimate valuation and an increased allocation to higher-risk, economically beneficial investments like infrastructure would reduce deficits and ease the strain on sponsors.
Royal Mail closure plan flags pulldown effect of low rates
The perennial question of whether it is possible to keep defined benefit schemes open to accrual has resurfaced after Royal Mail Group said it could not afford to keep its DB scheme open beyond 2018.
However, best estimate approaches have tended to be criticised for being less compatible with the buying out of scheme liabilities in the event of sponsor insolvency, because they differ significantly from the cost of insuring liabilities with gilts.
Defending gilt-based discount rates, Nolan said: “It’s more like the way the insurance companies do it so it keeps that gap at least in the right ball park.”
