Sir Terry Leahy kept Tesco’s defined benefit scheme

It may seem counterintuitive to talk about Tesco’s ‘values’ in the wake of the £263m profits misstatement, but in light of Tesco’s decision, under CEO Dave Lewis, to scrap its final salary defined benefit pension scheme last week, it’s interesting to compare and contrast this action with Sir Terry Leahy’s passionate defence of the Tesco pension scheme, as outlined in 10 Lessons in Management, Sir Terry’s 2012 autobiography.

In a chapter on ‘Values’, Leahy spent several pages on the “long, slow and – to me – sad  demise” of the defined benefit final salary pension scheme and how he fought off pressure from both the City and its pension advisers to save the Tesco scheme.

Sir Terry was very clear that the Tesco pension was crucial to employee loyalty.

“How an employer helps prepare [its workers] for old age says a lot about that employer. Just as you judge a society’s values by how it treats its old people, you can judge a company’s values by how it helps people for life after retirement. Given that Tesco aspired to ‘treat people how we like to be treated’, our pension scheme had to meet our employees’ expectations of what fair ‘treatment’ would be.”

But as he explains in the book, by 2000 the Tesco scheme, like all final salary pensions, faced “a serious problem”.

People were living longer. Low inflation meant pension schemes’ liabilities – the pensions the scheme would have to pay out in years to come – cost more to fund. Stock markets underperformed their long-term average for nearly a decade. And the Government changed the tax regime, making them much less tax-efficient, [while] also introducing a raft of legislation to protect people’s pensions (after a number of pension scandals), which made pensions much more costly to provide. Any one of these developments would have posed a significant challenge to a pension scheme. Taken all together they brought into question the viability of pensions as a company benefit.”

Leahy believed what was needed was a debate about long-term savings.

“Instead, the defined benefit company pension scheme, which had been so lauded, was suddenly friendless. A trickle of companies announced the closure of defined benefit schemes, replacing them with defined contribution schemes or, in some cases, no scheme at all. And that trickle soon became a flood.”

Sir Terry felt that a defined contribution schemed shifted the liability from the company in a way that damaged employee loyalty as well as the performance of the pension.

“A defined contribution scheme shifts the liability from the company (usually an experienced investor and administrator) to an individual who generally has little experience of investment or administrating a pension. If managed by the individual who is paying into their own pension, advisers’ fees can eat up 30 to 50 per cent of an uncertain return. So one consequence of the move to this type of scheme was a decline in the value of a pension. Another was a decline in employee loyalty, as people came to feel that the company they worked for no longer cared about their retirement.”

Tesco, as the largest private employer in the UK, was affected by these challenges like everyone else. And its advisers said that Tesco should follow the herd and join the stampede for the exit. The board did not agree.

“We decided instead to modify our defined benefit scheme from one based on an employee’s final salary to one based on the salary earned over the employee’s career. The scheme member would still have a defined benefit at retirement, but the cost to the employer would be both more predictable and, in some cases, slightly lower.”

Sir Terry outlines a number of reasons for bucking conventional wisdom.

“All Tesco’s staff had always automatically enrolled into our pension scheme, so the vast majority of staff were members. Our pensions, therefore, were not a perk for a few senior employees, but something in which everyone had a stake and an interest. Furthermore, on our board sat both long-serving executives (who had grown up in the company and readily identified with the employees) and independent directors: they all understood that the Tesco pension benefit was one of a number of long-term benefits that allowed relatively low paid staff to share in the company’s success. Consequently, the board always recognised pensions as part of a wider culture which rewarded staff loyalty, and contributed to high staff morale and commitment – all vital to the success of the Tesco brand.”

A shift from a defined benefit to a defined contribution scheme would therefore grate with Tesco’s values.

“It was too big a shift of responsibility from management to our employees, many of whom had little experience of long-term saving outside the company schemes.”

Not that Tesco ignored the problem.

“We knew we needed to change: we could not continue as we were. So we approached the problem, admittedly a serious one, like any other business problem, in the belief that if it was addressed head-on it could be managed.”

Tesco therefore shared the problem with its staff.

“We gave annual updates on the cost of providing a pension and asked staff to meet their share of the increase. Some senior staff contributed more than their share, because they trusted the company was doing the best it could and they could see it was better than the alternative.”

The problems and the closure of so many other schemes helped Tesco in a sense, he writes.

Whereas before employees may have taken the benefit for granted, now they certainly knew its value and were as determined as we were to see if we could manage our way through the problem. Offering a good pension became more of a competitive advantage in employment than ever before. It confirmed that our values meant something as Tesco followed its own path when it would have been easy to follow others.

Tesco actually managed its pensions better as a result, claims Sir Terry, “so that the cost of administering them actually dropped over time. We gave the subject much more attention. We employed better people to manage pensions and were able to run our scheme with very good returns (and with some of the lowest administration costs in the industry).”

At the time of writing his autobiography, in 2011, Sir Terry could proudly write that “Tesco today is responsible for more than 20 per cent of all members of open defined schemes in the UK private sector – a remarkable ratio for a business that employs about one per cent of the private sector workforce. A Tesco employee will retire on a pension which is two and a half times larger than that of someone who has made similar payments to a defined contribution scheme.

He ends: “The decision was difficult, the financial costs in the short term ran into hundreds of millions of pounds, but it was the right thing to do.”

With many Tesco employees earning close to the minimum wage, the defined benefit pension scheme has been a key means by which to secure employee loyalty. And Sir Terry was clearly hugely committed to its preservations on moral but also long term financial grounds.

The question is now: with Dave Lewis announcing last week plans to finally scrap the defined benefit pension scheme, will this be a decision he lives to regret? Has Tesco lost its hidden trump card in the employee stakes?