Royal Mail set to close 'gold-standard' pension scheme

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Royal Mail’s “gold-standard” pension scheme is at risk of closure and the company is braced for crunch negotiations with trade unions after it told workers the plan was “unaffordable” beyond 2018.

The UK’s dominant postal operator pays around £400m a year in cash towards a defined benefit fund, which guarantees a retirement income to members including two-thirds of its 140,000-strong workforce.
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However, the company has written to employees saying that a deterioration in financial market conditions meant the annual cost of keeping the plan open was likely to more than double to £900m.

In a letter sent in June, management described this increase as “simply unaffordable” and said it did not believe it could continue to run the plan in its present form beyond a prior commitment of March 2018.

Royal Mail had previously told investors that prevailing economic conditions suggested the plan would not be affordable beyond its commitment date.
The looming change is a sign that Royal Mail, which was privatised in 2013, is leaving behind the traces of its public sector heritage by adopting a form of retirement provision now commonplace in the private sector.

It comes at a time of growing concern over companies’ ability to honour pension promises to workers at a time of record low interest rates. High-street retailer BHS, for example, collapsed into insolvency with a large pension fund deficit, leaving some 22,000 members facing cuts to their retirement income.
Solving the issue will be crucial for Royal Mail, which is undergoing a modernisation and cost-cutting programme as it grapples with falling letter volumes and fierce competition in parcel delivery.

Royal Mail’s defined benefit scheme closed to new members in 2008 and has a surplus as a result of changes agreed with unions three years ago. But it has been running this down to help reduce its annual pensions costs from about £700m a year to nearer to £400m. The company expects the surplus to be exhausted by 2018.

A triennial valuation of the scheme is under way by its trustee. As part of that Royal Mail will propose a funding arrangement for the five years after 2018. A spokesperson said early indications from the valuation suggested a rise in annual costs to £900m, which was “not sustainable”. Royal Mail had free cash flow of £292m in the last financial year.

The spokesperson added: “We understand how much our people value their pension benefits. We committed to keep the Royal Mail Pension Plan open to future accrual on a career average basis for existing members without further changes, at least until March 2018 . . . We are talking to our unions about the future of the plan after [then]”.

Pension experts said a likely outcome was the introduction of a less-generous defined contribution scheme, which invests members’ savings but does not assure a minimum pension income. Past accruals in DB schemes are legally protected.

The company will need to win the support of the Communication Workers Union, which represents blue-collar workers and does not accept the need for the closure of DB scheme. Informal talks have already begun, it said.

Ray Ellis, CWU acting deputy general secretary, said: “We recognise the potential scale of the costs come 2018. However, we challenge some of the assumptions on the valuation — for example the strength of the employer covenant.

“Our main objective is to keep the DB scheme open to future accrual and we will continue to meet with Royal Mail to discuss the future of the pension scheme,” he added.

John Ralfe, an independent pensions expert, said one option was for Royal Mail to put all employees on a more generous defined contribution scheme than the existing one that 42,000 employees already pay into. This could save cash, he added.

“Virtually all small defined benefit schemes are already closed, and it is increasingly happening for large schemes,” he said.

Dominic Edridge, analyst at UBS, said: “Given the potential cash impact of any settlement from the pension, and the amount of variability between the upside and downside, it’s clearly very important for the valuation of Royal Mail.

“The market is probably assuming on a cash basis the outcome will be similar to the cash cost today.”