Page last updated at 23:54 GMT, Wednesday, 25 February 2009

Paying for postal staff pensions

By Ian Pollock
Personal finance reporter, BBC News

Protesting postmen in London
Postmen protest in London against the part-privatisation of the Royal Mail

The state of the Royal Mail pension scheme seems, rather suddenly, to have become a vital public issue.

This week, the chair of the scheme's trustees wrote a letter to Lord Mandelson, subsequently leaked, warning of a catastrophe for both the pension fund and the Royal Mail itself if the company was not part-privatised.

This was the central recommendation made last year by businessman Richard Hooper in his government-sponsored review of the future of the UK postal service.

But amongst all the hoo-ha about whether or not a partial privatisation would be beneficial for the Royal Mail, it is only now sinking in that he identified the size of the scheme's deficit as the single biggest financial problem facing the service.

So worried was Mr Hooper that he made no fewer than 80 separate references in the 167 pages of his report to dealing with the pension problem.

By contrast, there were just 25 references to his semi-privatisation plan - the need for a "strategic partnership" with a private investor.


Of course, the size of the pension scheme deficit is not the only problem bothering Royal Mail management and the government.

The problem for Royal Mail is that it is obliged to pay off this deficit from its own earnings

Adam Crozier, chief executive of the Royal Mail, told MPs this week that the company faced a continuing and sharp fall in the number of letters people send, not least because of the ubiquitous use of e-mail these days.

Within five years, he warned, the decline in letters would mean that delivering parcels would make up 75% of all Royal Mail profits.

Rival postal services can employ the company to deliver their letters at charges of just 13p a go, which it finds frankly uneconomic.

And it wants to spend huge sums on buying new sorting office equipment, and on recruiting external management expertise, to further modernise its operations.

Rising deficit

So where does the pension scheme come in?

The answer is startlingly simple.

The deficit in the scheme - the difference between the value of the assets it needs to pay pensions, and the value of the assets it actually has - is shooting up.

Just three years ago, it stood at £3.4bn, but thanks to increased longevity of postal staff and lower anticipated investment returns, the shortfall is now estimated to be about £5.9bn.

Both Mr Crozier and Lord Mandelson have said they expect the next scheme valuation, starting soon, to put the deficit as high as £8bn or £9bn.

So what? Isn't a few billion pounds just loose change in these days of bank bail-outs?

The problem for Royal Mail is that it is obliged to pay off this deficit from its own earnings.


Currently the deficit payments to the scheme are running at £284m a year, on top of the normal pension contributions.

Protesting postman in London
Younger staff will have to work longer to earn the same pension as before

So together, they total £850m a year, and this level of payment will continue for the next 15 years.

If the deficit becomes even bigger when this year's scheme valuation is published, so will the repayments demanded from the employer and, possibly, the length of time over which they will be made.

Even if the Royal Mail hoped to be consistently profitable over that time, such a call on its money would swallow up all its spare cash and more.

In fact, Mr Crozier warned MPs that the firm would fall into the red again this year.

No wonder he described the deficit as a "giant millstone around our necks".


If you thought nothing had been done about all this until now, you would be wrong.

In early 2008, the Royal Mail pension scheme was changed drastically to make it much cheaper in the long term, and to make it a much inferior deal for postmen and women.

It now offers new recruits a "money purchase" fund, rather than a final salary scheme.

And all existing members were moved to a so-called career average scheme.

Along with raising the standard retirement age to 65, the Royal Mail hopes these changes will eventually cut its total contribution rate from about 30% of staff salaries now to about 11%.

But that will take a long time - and may, in fact, never be achieved if the deficit just keeps on rising.

What next?

Richard Hooper did not use the phrase "partial privatisation" once in his report.

If that money had been steadily invested over the past 19 years, there is little doubt that the scheme's deficit would be far smaller now

Nor did he use the word "nationalisation".

But that second concept is, in fact, the solution he put forward to the Royal Mail's pension problem.

He suggested that, one way or another, the government should lift the burden of the deficit from the company by simply taking over the scheme and filling in the financial hole with taxpayers' money.

That could be done, he suggested, in various ways.

The government could pass a law to take over the scheme's assets and obligations, paying the pension out of taxation; use state funds to pay insurance firms to pay the pensions; or continue to run the fund as a stand-alone operation, but with government backing.

Lost investments

Would any of those ideas be a gesture of astonishing generosity to the postal staff, past and present?

The Communication Workers Union points out that all this involves a very large chicken coming home to roost at the Treasury.

For 13 years, from 1990 onwards, the Royal Mail - in common with other large organisations - made no contributions at all to the old pre-1987 section of its scheme, in a grand contribution "holiday".

It should have been paying in money at a rate of 9% of salaries per year.

Ostensibly this was to avoid running up a very large surplus, which was a very common phenomenon in final salary pension schemes in the early 1990s.

But the saving of £1.5bn over that time - when staff were still paying in 6% a year - rather neatly covered the £1.3bn that the Royal Mail paid back to the Treasury during that time in an annual dividend.

If that money had been steadily invested over the past 19 years, there is little doubt that the scheme's deficit would be far smaller now.

If the £1.5bn of annual payments had been invested in shares and bonds over those years, and had grown at an average annual rate of 6%, including dividends and interest, then the fund would now have an additional £3.1bn.

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