Royal Mail closure plan flags pulldown effect of low rates

DB pension schemes open to accrual are becoming increasingly rare, although the trend to closures has levelled off. Latest figures from the Pension Protection Fund’s Purple Book, covering nearly 6,000 DB schemes, show that more than half are closed to new entrants, with another 34 per cent of schemes closed to future accrual.

In its 2015 analysis of DB provision among blue-chipcompanies, professional services firm KPMG said just 54 of the FTSE 100 companies still offered DB schemes and predicts that by 2018 fewer than 40 of them will be open to employees.

Royal Mail’s position is unusual in that it is a public organisation turned private, but the reasons for its proposed closure mirror those seen at many companies.

Every company operating a DB scheme is having to think about whether or not it remains affordable

Darren Redmayne, Lincoln Pensions

Interest rates are prohibitively low

In its latest half-year results, the postal service provider hinted that the scheme cannot remain open in current market conditions with continued low interest rates.

“Current economic conditions would suggest that keeping the defined benefit scheme open to accrual beyond 2018 will not be affordable,” Royal Mail stated in a report.

A spokesperson from the company later added: “Royal Mail has started discussions with the trustees and [the Communication Workers Union] over what happens beyond 2018. These discussions will extend into next year.”

It had previously said that maintaining the DB scheme would be difficult even after the pension fund’s £37.5bn past-service liabilities were handed over to the government in 2012 to make way for Royal Mail’s privatisation.

But for pension rights accrued since then, and subject to certain conditions, the plan was to be kept open until March 2018 “at least”.

However, with its latest announcement Royal Mail has made it clear that no extension will be possible if the state of the economy and low interest rates see no change.

Impaired competitiveness

Darren Redmayne, head of covenant adviser Lincoln Pensions, said running a DB pension scheme can cost a company as much as one-third of salary, making it an expensive benefit.

He said it is “increasingly challenging for a number of companies to remain competitive”, particularly in sectors where margins are tight and competitors do not provide DB.

“Every company operating a DB scheme is having to think about whether or not it remains affordable,” he said.

Redmayne said there are several reasons why DB is costly, including lower investment returns and increased longevity, but added that what could change the narrative of the expensive DB scheme is a recovery in gilt yields, which could “dramatically increase the funding position of a large number of schemes”.

He added: “I always find it sad when a DB scheme closes to future accrual because I think that they’re an excellent benefit and also an arrangement that really is a kind of pension arrangement rather than a tax-efficient savings pot.”

But Simeon Willis, director at consultancy KPMG, said even if interest rates went up it would not recreate the environment that existed 20-30 years ago.

Employers could make schemes more affordable by removing the “double whammy of having salary rises and accrual” and moving from a final salary arrangement to a career average revalued earnings scheme.

Willis added defined contribution schemes can provide a “high probability” that a certain pension income will be achieved.

He said: “There are some examples where there are fantastically generous DC schemes, where the employer’s contributing 15, 20 per cent.”