ANALYSIS. Pension scheme deficit: Tata Steel finds the going tough

Tata Steel’s plans to move its remaining employees from a defined benefit to a defined contribution scheme will allow it to tackle a £2-billiondeficit, but in the short term, are unlikely to greatly reduce its costs.

Tata Steel paid around £103 million towards the British Steel Pension Scheme last year. Though largely made up of normal contributions — the 13 per cent of salary it puts in on behalf of employees — around £28.2 million is made up of payments it must make towards reducing the £553-million deficit declared following the 2011 actuarial round of the scheme.

Under that agreement reached with the pension scheme and the UK pension regulator, it has to plug the deficit by 2026. With the current actuarial round for the period ending in 2014 expected to show a £2 billion deficit, Tata Steel will have to reach a new agreement on reducing this deficit, with far higher annual payments says John Ralfe, an independent pension consultant, former head of corporate finance at British retailer Boots.

Tata Steel plans to close its £14 billion (in March 2015) British Steel Pension Scheme, as it attempts to tackle the deficit. The move would impact around 91 per cent of its current workforce, or 16,000 employees (the scheme has 135,000 members, including pensioners and those who have left the company but are yet to retire).

In switching employees to a defined contribution scheme, Tata Steel would be following a global trend away from defined benefit schemes, as longer life expectancy has put far higher cost burdens of such schemes on companies running them than was originally anticipated when first set up.

The financial credit crunch – and resultant turbulent markets has meant that even the best run pension funds - and the British Steel Pension Scheme by all accounts has a good reputation (winning a European award for long-term investment strategy in 2013) have struggled to meet the rising costs.

The Indian government shifted employees to a defined contribution scheme in 2004, and in the UK, pretty much all small and medium sized businesses have made the move. While a handful of FTSE 100 companies still maintain such a scheme, the costs of running the scheme are unlikely to be very high as most closed their schemes to new entrants many years ago. Tata Steel, on the other hand, introduced the defined contribution scheme for new employees last year.

“You could almost argue they were late to the party,” says Simon Taylor, a partner at Barnett Waddingham. No members of the FTSE 100 remain open to new members. The number of those with defined benefit schemes are likely to fall further when new rules governing national insurance contributions come in next year, which will raise the costs of running such schemes. “It will be another nail in the coffin of defined benefit pension schemes,” says Taylor.

“We have spoken to lots of companies and by April next year, they are either saying they will close the scheme or they don’t have many in the scheme so it wouldn’t be a higher cost to them.” Tata Steel, which has around 91 per cent of its employees in the scheme, would, of course not fall into the latter category.

The large number of former employees who remain within the pension scheme (their benefits would not be impacted, while those earned by current employees within the scheme are frozen and increase in line with inflation) will mean that the overall impact on the company’s deficit position is going to be modest. “They can shave something off their liabilities and also reduce their annual costs,” says Ralfe. “This isn’t going to let the company off the hook – they still have to deal with a large deficit and deficit contributions which will require a large amount of cash.”

The proximity in timing between Tata Steel’s decision to close the scheme to new members and to close it completely has exacerbated the company’s problems, says Ralfe. “Tactically, they will find it hard to do things at the same time – closing to new members, reducing the generosity for existing members and then finally closing altogether to existing members is something that most companies have done gradually over ten years, so what Tata Steel now has is 90 per cent of the workforce unhappy rather than just 10 or 20 per cent.” (A major issue for unions is that under the proposed scheme, employees would no longer be able to, with the agreement of management, retire at 60 rather than 65, though Tata Steel has pledged steps to mitigate the impact of this.)

Tata Steel says it expects its costs to remain roughly the same under the new scheme as it was under the defined benefit scheme – roughly 13 per cent of salary. (The company contributes 10 per cent under the current DC scheme but anticipates that associated costs would take this up to 13 per cent. DC contributions in the UK currently range between 5 and 15 per cent, though the top end is largely in the banking and financial services sector).

The main advantage of Tata Steel will be risk reduction, says Taylor. “They are cutting off the accrual risk of costs going up in the future.”

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