Tesco's pension headache is a real challenge because of the financial strength of the company say experts

Oliver Gill
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Trustees may need extra assurance that pension liabilities can be met by the supermarket (Source: Getty)

Pension experts warned that Tesco's ballooning pension deficit could cause the supermarket problems when it comes to tricky conversations with the scheme's trustees.

The deficit – which doubled to £5.9bn – was higher than anticipated and will likely prompt detailed scrutiny by the trustees, in particular when it comes to next year's triennial valuation.

"The ballooning deficit at Tesco is another wake up call for the UK’s fallen angels," said Lincoln Pensions managing director Richard Farr.

Read more: Tesco's pension deficit has more than doubled in six months

Whereas previously a widening gap could have been bridged by a strong company covenant – the ability of a company to generate sufficient profits in the future to meet its pension commitments – Tesco's recent financial travails mean it is in a trickier position.

"The strong covenant of the [Terry] Leahy regime meant that aggressive out performance assumptions and resultant low funding obligations would only ring true whilst Tesco maintained its darling status. Cometh the hour, cometh the turnaround expert Mr [chief executive, Dave] Lewis, has meant the trustees are running for cover with a much more prudent and realistic funding assumption," said Farr.

Read more: Pension deficit rise relaxes in September

However, when it comes to negotiations between the trustee and company, a wider gap between a schemes assets and liabilities does not necessarily mean that a company in Tesco's position will have an immediate cash call according to Lane Clark & Peacock partner Bob Scott.

"Additional contributions could be paid over an extended period or the contribution pattern could be back-end loaded, instead of cash, they could provide e.g .asset-backed security arrangements. So it’s difficult to say exactly what the impact will be on cash contributions," he said.

Aggregate pension scheme deficits have spiralled since February in particular, predominately as a result of bond yields collapsing in the wake of the Brexit vote and the Bank of England lowering interest rates. But Tesco's deficit has considerably outstripped the average pace and Charles Cowling of JLT Speciality explained this was due to the investment strategy of the scheme.

Read more: Analysts applaud Dave Lewis' efforts to turn around Tesco

"Tesco is almost unique amongst the very big schemes because it's got a very high allocation to growth assets and low allocation to [long-dated] bonds," said Cowling.

Many pension schemes hold investments in long-dated bonds, whose value mirrors that of liability values. Where schemes assets are more heavily weighted towards equities there is a mismatch as the recent increase in markets has failed to keep up with the pace in the increase in liability valuation, causing deficits to widen even further – as is the case with Tesco according to Cowling.

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