Collecting and delivering post is hard work (much pay is deferred so workers can retire in ease)

The Royal Mail is consulting with its staff on closing its final salary scheme to future accrual. This is a public consultation, the Royal Mail are putting it to their staff that an increase of pension contributions to 50% of pensionable pay is unaffordable.

I don’t think anyone would disagree. If you are competing in a market where the market normal is 2% (1+1), it is hard to see how you can remain competitive , pay such contributions and continue to employ large numbers of sorters, postmen , counter staff , even managers. From a business perspective, such pension contributions would result in mass redundancy.

From the staff’s perspective, I suspect most would consider they could do rather better with something like a 50% increase in wages!

With both Unite and the CWU threatening industrial action, it is clear that something has gone wrong – but what?

Royal Mail says that it could not afford an anticipated rise in the annual cash cost of the plan to about £1bn starting in 2018, up from £400m at present, caused by a deterioration in financial market conditions. It is currently drawing down a surplus in the fund to supplement its contributions but expects that to be exhausted in just over a year.

The projected costs increase not because the fund is in deficit, it isn’t – but because the fund has no means of generating an investment return needed to meet future obligations – if the scheme remains open to future accrual.

The fund is almost entirely invested in bonds . Bonds have de-risked the scheme but emasculated it. If it is to close, the scheme should be no burden but if it is to stay open, it will have to become a pay as you go arrangement with the employer paying as the members go.

The scheme is in bonds with good intent. The Trustees have listened to the advice of commentators who argue that it is good economic sense to match liabilities and assets. The trustees have secured the existing members from the perils of the PPF and satisfied the Pensions Regulator in their prudence.

It is hard to blame the Trustees for doing what has become “received wisdom” but it is equally hard not to point to the absence of any growth producing assets in the fund as the root cause of the problem. The £7bn odd of the £7.6bn fund is buying various debt instruments at a time of massive demand and under supply, those assets are over priced and are producing no real yield. This is the institutional manifestation of the transfer value problem we have been looking at in recent days. The Royal Mail transfer values should be looking marvellous with the discount rate trending to zero and no insufficiency report, critical yields should be on the floor.

But the solvency of the scheme today, is at the expense of the viability of the scheme tomorrow. The only way that the Royal Mail can reverse out of this situation is with the help of the Trustees. Were the current bond positions to be unwound and the scheme reinvest with an eye to growth, then a best estimate approach to the funding position would see the eye-watering £1bn a year being demanded in future contributions , drop substantially.

But – and there is a but – this would be to unwind the current plan of the Trustees. It would be to ask people with strongly held beliefs to accept that they have been mistaken in acting with the courage of their conviction. This is a big ask.

A couple of days I met with Nigel Wilson , the CEO of L&G and I asked him what was the cause of the “pension crisis” we were in. I looked around the room expecting him to run to a computer and show me a snazzy chart showing market data. But there was no computer, there were just some books and chairs (and a lot of pictures of Newcastle United players).

Nigel Wilson thought for a second and replied.

People.

If the cause of the pension crisis is “people”, then my computer says the solution to the pension crisis is also “people”.

The problems at the Royal Mail are to do with the Trustee people’s obsession with managing economic risk – an obsession fuelled by the weight of their advisers. But they have acted blind to the long-term market lessons that over tell us that de-linking a scheme from the economic growth of the market will lead to failure.

Failure is an inability to meet what Con Keating calls “the initial grants to members”.

The 90,000 Royal Mail workers and their representatives have been granted rights to pensions based on assumptions of future accrual. When these grants were made, they were considered economically viable. To most ordinary people they still are economically viable. But to the “experts” they are not economically viable, they represent an unacceptably high risk.

Experts (even postmen) can get it wrong (with good intent!)

I worry that, as with the pension scheme of the USS, the risk of failure of the pension scheme is dwarfed by the risk of failure of the Royal Mail (and indeed our University system). Universities have students to fall back on and state set fees, but the Royal Mail no longer has the tax-payer’s long-stop support.

The Trustees have to seriously consider whether – as people – they have got it wrong. The Trustees of the Boots scheme had to do the same after it found it could not afford a pure bonds strategy.

I was asked yesterday whether our FAB index could help, no it can’t!

Simply applying a notional discount rate based on average asset distribution (bonds and equities) to a scheme which has de-risked to bonds is living in lah lah land. the message of FABI is not to be imprudent but to look at prudency differently.

The Royal Mail pension scheme should be aiming to be around in perpetuity and so should the Royal Mail. If someone told me we didn’t need things delivered to our door, I would laugh at them. I would also laugh at the thought that postmen work for their wages on the prospect of being poor in retirement.

The expectations that the pension grants will be paid in full, is as clear as our expectation that the letters will arrive in the right place at the right time. Currently the Trustees of the Royal Mail Pension scheme have lost sight of both these things. They risk damaging the Pension Scheme and the Royal Mail through an investment strategy that however well intentioned – is wrong.

Nigel Wilson is right – people are the problem – people are the solution. The negotiations between employer-staff -unions and trustees can only be successful if conducted with grace and humour and an acceptance that

to err is to be human, to forgive to be divine!

Let’s hope that the pension can be re-set, strikes avoided and most importantly, the pension grants be paid without the destruction of jobs and a great business.

This wasn’t very long ago