Is Tesco about to close its Pension Scheme?
by Dr. Ros Altmann
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Pressure of poor business performance and rising pension deficit may force closure
Artificially depressed bond yields having damaging effect
There are widespread rumours that Tesco may be about to announce the closure of its pension scheme – one of the last remaining open defined benefit schemes in the private sector. Most analysts have called for the scheme to close.
With the latest sharp fall in gilt yields, it is expected that Tesco’s pension deficit will have increased significantly. In August 2014 it reported a £3.4bn pension fund shortfall. Its £8bn of assets (up from around £6bn in 2012), did not keep up with the rise in 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 is growing and scheme closure is thought to be imminent.
Tesco has been committed to providing good pensions for its staff and has tried hard to retain the generous defined benefit promise 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 is putting pressure on management to find ways to cut costs further.
Will closing the scheme solve Tesco’s pension deficit problem? Certainly not. 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 could affect shareholders via lower dividend payments as company resources have to be shared with the pension scheme.
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.
If Tesco does close its scheme, this will be another pension casualty of policies aimed at stimulating the economy. In the long-run, pensioners will be poorer as a result. This may have been inevitable as 21st century companies cannot 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.