A1 at Lloyd's

The job of the Lloyd’s Register is to examine merchant ships and classify them according to their condition. The highest classification, ‘A1 at Lloyds’, indicates by the letter A that a ship’s hull is in first class order and by the number 1 that the trappings are also sound; in other words that the vessel is seaworthy inside and out.

David Moorhouse, the chairman and chief executive of the London based Lloyds Register Group, the risk management organisation that has developed from the shipping registry, aims for the same sort of classification for the group’s UK pension fund.

Moorhouse says the Lloyd’s Register Superannuation Fund Association, a defined benefit (DB) scheme with some 1,600 active members, has been seen as an important employee benefit. “Lloyds Register is an unusual group in that it’s an industrial and provident society. This means that we are restricted as to the way we can reward staff.

Because the group has no shareholders as such, we can’t give shares in the group to individual members of the staff. “So the pension then takes on a level of significance because it’s one of the few fiscal tools that we are able to use to anchor our key staff to the business long term.”

However between 2000 and 2003 plunging global equity markets threatened the asset base of the fund. The triennial valuation of the UK pension fund, with a value of £403m, revealed a deficit of £62m (e90m) in March 2003. Meanwhile, the market value of Lloyds Register’s investment portfolio had fallen from £153m (e221m) in June 2000 to £115m (e 166m) in June 2003, a fall of almost 25% over the three-year period.

On top of this, lengthening longevity came to be seen as a greater threat even than volatile markets. Moorhouse, who chairs a committee of six pensions and investment advisers at Lloyd’s Register, decided it was time to take stock: “We found ourselves facing some pretty hard decisions about whether we could afford to maintain the pension that we had, and how hard we should fight to keep it.

“Right at the outset we decided we wanted to keep it in a form that was affordable long term. That led us to thinking that we needed to crystallize the liability as much as possible within the fund so that we could be more deterministic about the future. We did not want to close the scheme, but we couldn’t afford the scheme in its current form.”

The first step was to plug the £62m deficit, and Lloyd’s Register has chosen to pay this off over 14 years at the rate of £6.6m a year. The second step was to create a hybrid pension scheme for the Lloyd’s Register Group – a defined contribution (DC) plan with an option to join the existing DB scheme.

Lloyd’s Register set up what it calls a ‘nursery scheme’ for new employees. This is a DC scheme to which both employees and employer contribute.

After eight years in the scheme, an employee has the opportunity to join the existing defined benefit scheme.

Moorhouse and his committee set the threshold of entry at eight years to take account of current work patterns, says Moorhouse. “Lloyd’s Register has a long service culture, with people typically doing between 30 and 40 years’ service. But in the past 10 years, there has been a much greater movement of people, and if people are going to leave they will generally do so in the first eight years of their employment.”

Employees who choose to join the DB scheme join on the same basis as everyone who has joined the scheme to date. Those who choose to stay in the DC scheme can expect the employer’s contribution to increase progressively, so that by year 20 of their service the employer’s contribution is 15% and between 20 and 25 it is 20%.

The DC scheme has attractions for early leavers as well, says Moorhouse. “One of the big factors will be the money you can take with you if you do leave at year 10. Because were you to leave at year 10 in the contribution scheme you would take significantly more than you would take from the defined benefit schemes.”

The DB plan has been slightly modified in the new arrangements. The option to retire without actuarial reduction at 60, two years ahead of the normal retirement age, has been removed.

“That means 2.5% difference on the funding rate, which for an option that affected so few people, was something we could do to bring it into line with what was acceptable,” says Moorhouse.

The employee contribution of 6% was reduced to 3% in the bull market years this has been restored to 6% Lloyd’s Register’s contribution has risen from 4% to 18.3%.

Another task facing Moorhouse and the committee was how to restore the value of the fund. They decided to that the fund had to be managed more actively. “To maintain the fund one needs to take as significantly greater active role in its management than was perhaps the case in the good old days of bull markets.”

This meant replacing the incumbent asset managers with others. Lloyd’s Register retained only one manager - Legal & General Investment Management - to run the passive part of the pension fund portfolio “We decided after many years of dealing with certain portfolio managers that their ability to manage the current situation was severely limited, mainly because most of them had only ever worked in bull market conditions, and had never worked in a bear market.”

They chose a value rather than growth investment style. “The choice of a value manager that worked extremely well. We were more than pleased; it well outperformed the benchmark in those first seven months,” says Moorhouse. “It has helped us establish some build-back in terms of the monies lost. We lost about £200m and we managed to replace about £100m of that by December 2003.

“I don’t want to point fingers at individual companies but I don’t believe that without actively making changes our fund would have recovered to the level it’s at today. “

Lloyd’s Register faced an additional problem of an unfunded pension scheme for the 4,400 employees based outside the UK “Many years ago the group set up an unfunded scheme for its overseas employees This was free at source, funded centrally and sat on the LR Group’s balance sheet as an unfunded liability,” says Moorhouse. “I’ve always been very uneasy with that because in today’s market no one can guarantee the longevity of their company beyond 10 years. To have a whole raft of pensioners sitting out there whose entitlement to money was the same as any other creditor of the group seemed to me to be something we had to deal with.”

Lloyd’s Register has taken steps to resolve this by creating a charge to the balance sheet of approximately 70% of the liability of the overseas fund. It is also negotiating with each of the overseas countries to move from this centrally funded free at source pension to a contribution scheme that will be funded in the country where the pension is drawn. The target to converted 85% of all outstanding liabilities by next May.

However, the need to conform to different tax regimes has made this a formidable task, says Moorhouse. “When you provide a pension from a central source that is unsecured, in many of the countries that’s allowed tax free to the individual. But as soon as you secure it then it attracts both corporate tax and personal tax.”

The creation of a 70% charge should help, he says, “We don’t secure 100% of the liability and it is still part of our balance sheet and isn’t judged by those countries to be a secured element of pension payment.” 

However, the real benefit of the charge is its ability to grow in value. “Our view is that we will be able to grow the value of that 70% charge, because to create a charge you have to define all the elements within that charge. So it is like a ring-fenced element of investments, and as those investments grow so will the value.

“Because we are in the process of stopping those liabilities centrally and making them funded locally, then, as people and their entitlement come through the company, they will reach a peak, - which is our 100% – and then they will start to decline again.

“When in 15 years time the fund is equal to or greater than the value of the assets contained in the charge then the charge will return the surplus over that liability to the Lloyds Register.”

This ingenious piece of financial engineering should make the various Lloyds Register pension schemes both secure and sustainable, Moorhouse suggests.