Although many of Europe’s employers, panicked by volatile markets and new accounting rules, are engaged in a Gadarene rush to close their defined benefit (DB) schemes, a few companies have held back. They have decided that the DB option is in the best interests of their employees and have tried to design a DB option that is both affordable and sustainable.

One such company is the Musgrave Group, a 130-year-old family-owned food distribution business based in Cork in the Republic of Ireland. The group employs 7,500 people in five divisions in Ireland, Northern Ireland, the UK and Spain.

The 2,700 employees of the two Irish-based divisions - Musgrave Supervalu Centra franchise operations and Musgrave Wholesale Services - are members of the Musgrave Limited Pension Scheme, a DB scheme introduced in 1968.

The original scheme was unusually generous in DB terms. It had an accrual rate of one forty fifth for each year of continuous service, which provided for a full two-thirds of final salary after 30 years. It was non contributory, with the employer playing 16% of pensionable pay. It also provided a guaranteed escalation rate of 3% a year.

By the early millennium, the scheme, in common with other corporate pension funds began to run into deficit, hit by a combination of falling bond yields, falling equity prices and greater longevity.

In an effort to reduce the costs of the scheme, Musgrave changed the terms of its benefits for people joining the company in 2002. It increased the accrual rate to one sixtieth so that a full pension became payable after 40 years. It also introduced an employee contribution of 5%.

A more radical solution was required when a valuation of the pension scheme in 2004 revealed a funding deficit of more than €40m. It was calculated that a contribution of 24.4% would be needed to fund this deficit. The company had already increased its contribution to 18% in 2003.

The 2004 valuation showed that the existing DB scheme was too expensive. Musgrave considered a number of options, including winding up the scheme and introducing DC, closing the scheme to new entrants, closing the scheme for future accrual and introducing DC as an alternative. Other, less likely options included further reductions in the accrual rate, possibly to one eightieth. It also considered reducing or removing altogether the pension escalation.

From the point of view of cost certainty, the obvious option was to close the scheme for all future service and introduce DC. Yet this ran counter to the culture and business values of the group. The Musgrave family has a Quaker background and runs its business according to five core values which it defines as honesty, achievement, working hard, long-term stable relationships and not being breedy.

Adherence to these values largely explains why Musgrave has tried to retain its DB scheme, says Noel Keeley, Musgrave’s group human resources director. “The values are the bedrock of everything we do, and the pension element of the company’s compensation framework has been based on the value of long-term stable relationships.

“The company recognised that if people were prepared to contribute throughout their lifetime to make sure the company was a success they should be reasonably and fairly looked after in retirement. That was arguably one of the reasons we decide to maintain the DB scheme.”

Yet if the firm was to maintain an affordable DB scheme, the employees would have to share some of the costs. In 2005 all employees, not just new joiners, were asked to make a 6% contribution.

“The aim was to continue to provide our employees with the best benefits possible while at the same time doing that in a way that was affordable for the company,” says Keeley. “That is being done through a shared responsibility for its maintenance involving a contribution from employees to keep the contribution rate of the company at a level which is reasonable and sustainable.”

An employees’ contribution rate was introduced in two stages. Members in the original pre-2002 version of the scheme contributed 3% in 2006, rising a further 3% to 6% in 2007. The contribution rate of members of the post 2002 scheme was increased from 5% to 6% in 2006.

The company also halved the guaranteed escalation rate from 3% a year to 1.5%. “That obviously had a very significant impact on the calculations of an actuarial forecast,” says Keeley, who explains that “1.5% typically is less than the rate of inflation but our hope would be that if things change and our fund returns to being fully funded, or even in surplus, we may be able to give more than 1.5%.”

Employees who decided either to leave or not to join the amended DB scheme were offered membership of a non-contributory DC scheme to which the company contributes 10% of pensionable salary. This was consistent with Musgrave’s aim to deal fairly with its employees, says Keeley. “You cannot people in a position where you insist that unless they pay a contribution they have no pension.”

The changes were explained to the employees in a major consultation exercise with SIPTU, Ireland’s largest union, and Musgrave’s Ireland-based employees. “We appealed to our workers to support us in the changes we were making because if we didn’t get that support we would be left with no alternative but to close the scheme and introduce a DC scheme,” says Keeley.

Following a road show in which the company put its plans to every employee, both union and employees agreed to the proposed changes. More than 90% of employees decided to stay in the DB scheme and pay a contribution.

Keeley says the speed with which company and employees reached agreement was remarkable. “From an industrial relations perspective, it is almost incredible that you could start a consultation process in October 2005 and implement deductions in April 2006. That’s a testament to the culture of the company and the people who work in it.”

The change in the DB plan’s design led indirectly to a change in the plan’s investment strategy. The consultation revealed that employees were worried that if they agreed to the changes, the company would come back to them in two years’ time to secure their agreement for further changes.

“People join a company on the assumption that the pension promise will not change,” Keeley says. “That led us to look at the investment strategy to see how we could bring more certainty to the continuation of the scheme and at least try to reduce some of the volatility that might cause us to make further changes.”

The pension scheme’s profile, with active members accounting for the largest share of the fund’s liabilities, also suggested that the fund should move to a more conservative investment

A study by the Musgrave scheme’s consultant Mercer Investment Consulting, which set the fund’s assets and liabilities against the company’s salary roll, showed that salary was becoming much smaller in proportion to assets and liabilities. This meant that it would become increasingly difficult for the company to absorb any deficits, and that the contribution rates as a percentage of salary roll would become increasingly sensitive to the investment result.

The objective, therefore, was to ‘de-risk’ the existing investment strategy. This was to be done in three ways: by implementing a liability-driven investment (LDI) strategy to align assets more closely with liabilities; by moving from active to passive management; and by reducing the equity weighting of the portfolio.


he LDI strategy was adopted after the discovery of a significant mismatch between the type of bonds that the Musgrave scheme was investing in and the scheme’s liabilities. “The average age of members of our scheme is 34, so it’s quite young,” Keeley points out. “This means that the liability we’re sitting on in most instances is around 31 years, yet we were investing in bonds that had seven or eight year durations.”

The scheme’s investment manager, Bank of Ireland Asset Management (BIAM), was able to offer an LDI product which constructed a portfolio of synthetic bonds, manufactured using swap contracts, split equally between Euro-zone nominal and inflation linked bonds.

The fund also moved to a purely passive management of both bonds and equities. The portfolio had a limited exposure to active management, with only 25% of assets actively managed. BIAM’s performance as an active manager had been disappointing, says Keeley, while its passive management had delivered returns in line with expectations.

“When we looked at the performance of passive funds vis á vis active funds over the last decade, we found that if you net out investment fees there is very little difference in performance,” he says.

“We came to the conclusion that we were simply not getting the level of outperformance that we would want for the level of risk we were taking. We believed that if we moved fully to passive management we would at least have better certainty about the performance we could expect.”

As well as moving into passive management, the company decided to reduce the pension fund’s exposure to equities, currently 70% of the portfolio. However, it decided that a dramatic reduction would be unrealistic, since it needed a significant exposure to equities to produce the return required to reduce the fund’s deficit. Instead it decided to reduce the exposure progressively to 60% over a period of three years. This would be done by ‘starving’ equities of further cash flow from contributions, which would be fed instead into the allocation to bonds.

The same process is being used to reduce the fund’s exposure to property, which is managed externally by Irish Property Unit Trust, the largest property trust in Ireland. This will be reduced from 7% to 5% over three years.

The fund’s exposure to equities is unlikely to fall lower than 60%, says Keeley. “We would want to maintain a reasonable proportion of the fund in equities to be able to pick up on the upside of the market one assumes that one gets in terms of the premium of equity performance over bonds.
Certainly the last couple of years have been

Of more concern is the effect of the growing demand for long-dated bonds, and the effect this will have on yields, he says. “We would be concerned about the effect of a lot of pension funds now moving into long bonds and as a consequence the yields coming down. With more demand leading to lower yields, we may end up in the situation of a dog chasing its tail.”

Musgrave implemented the new investment strategy, formalised in a statement of investment policy and principles, last November. Its progress will be monitored at half yearly intervals.

It is too early to measure the success of the new strategy, but the signs are encouraging. A deficit in the Minimum Funding Standard (MFS) is likely to disappear this year as the result of a three-year programme, including a cash injection of more than €15m, to put the Musgrave pension scheme back into the black

“We made a very significant cash contribution to the scheme not only to make sure we meet the MFS but also to try and ensure the continuation of the scheme,” says Keeley. “There are not a huge number of companies out there that would do that. But again what you’re seeing here is a commitment by a family-owned company to the people who work in it.”

So does the Musgrave Group’s determination to retain a DB scheme set an example to other corporates, which might be more concerned with maximising shareholder value than repaying the loyalty of their workforce? Keeley says there need be no conflict between the two objectives.

“We take the view that people create shareholder value, and that’s often forgotten in the plc boardrooms when they look purely at the numbers. Most of those numbers are driven and delivered by people, and if you don’t treat your people fairly and properly then over time you shareholder value will decline.

“So to us it’s a quid pro quo. We believe our success is down to our people and therefore we should do all we can to ensure that we provide them with the best benefits possible.”