ECB’s Euro-centric fund
In setting up the ECB scheme, the bank opted for the funded approach with assets benchmarked to the new currency. Fennell Betson reports
When the European Central Bank in Frankfurt was setting up its pension fund last year it took the opportunity to assess its approach to pension policy as Martin Carroll, head of the personnel policy division at the bank, said, when talking to a recent discussion panel in Frankfurt.
“Our conclusion was that pensions form a fundamental part of the compensation package and can be considered as deferred or lifetime pay.” He added: “This also emphasised that the scheme should basically be defined contribution”.
Not surprisingly, the bank decided to base its portfolios on the euro. “Being responsible for introducing the new currency, it was natural we would take it as the basis of the scheme.”
The bank took a very definite stance by stipulating its range of portfolios would be in Euro-zone equities, non-Euro-zone equities, Euro-zone bonds and cash.
At the time the ECB was laying the foundations for its plan, the introduction of the euro was in the future. But the bank did find that when it went into the market to recruit external managers, there did appear to be some hesitancy on their part to have a Euro- zone portfolio prior to the launch of the currency. “Even though Euro-zone portfolios were specified in our requirements, quite a number of managers recommended a strategy on a pan-european basis and hedging the currency risk,” Carroll said. “But we took the view that what we wanted to do was quite logical.”
The defined contribution approach attracted the bank as it fitted in neatly into this funding philosophy by stipulating contributions as a proportion of salary and crediting these to an individual account.Carroll pointed out that at the same time the scheme had to meet the needs of the bank with its career structure as an international organisation attracting highly qualified professionals not all of whom may serve a full career with the bank. “There is inevitably some turnover, and it is expected that the bank will recruit staff in mid-career who will only have a limited period with the bank, which emphasises the importance of portability, by allowing joiners’ benefits to be transferred in and leavers’ out.”
While the scheme is basically defined contribution, it was decided by the bank that there should be some guarantees given to staff particularly in relation to the minimum pension to be expected. A defined benefit style “underpin” was therefore introduced.
The DB underpin works in two ways: “The investment of the bank’s contribution is subject to a capital guarantee on an annual basis, so that whatever an individual’s fund was at the beginning of the year it is never going to be less than that (plus the current year’s contributions) at year-end. The other guarantee is a minimum of 2% per annum of revalued earnings over 30 years.” The maximum pension is 70% of final pay.
A further objective of the scheme is flexibility in a number of areas, including when the benefits may be taken. “We have a retirement zone from age 60 to 65, and there is the possibility to stay on until age 70, with the bank’s approval.”
Also considerable latitude was built in to allow staff to, for instance, increase their own personal pension, or to make provision for a higher spouse’s pension than the standard (to a maximum of 100%of the staff member’s pension). “We also wanted the ability to commute portion of the pension to cash, and this is limited to a maximum of 10 years’ service which can be commuted into cash, at the end of their career.”
To provide all of this, the decision was to have two funds. The bank contributes to the first fund – the core fund, an amount of 16.5% of salary. “This fund provides the staff member’s retirement pension, and is subject to the minimum guarantees and maximum limits of the plan.” On this basis the member of staff’s core benefit fund is credited with 96% of the investment return (in years when the return is positive) and the remaining 4% goes into a contingency reserve.
The way to provide for additional benefits, such as enhanced spouse’s pension or increased personal pensions, is through the second fund, the “flexible account”, as Carroll referred to it. This is purely for staff members’ contributions, which have to be a minimum of 4.5%, or can be up to a maximum of 16.5%. The members of staff may choose from a menu of options as to how this fund is invested.
One feature of the scheme, which was not possible to implement before the plan started, was that of having two investment committees. The aim is to have both, one for the core benefit account and the other for the flexible account, with six members each. “For the core account, the bank will appoint four members of the committee and the staff members/beneficiaries will elect two. The opposite prevails for the flexible fund with four member/beneficiary-nominees and two appointed by the bank.” Until such time as the structure is in place, Carroll said an interim strategy was put in hand for the first two years until the committee arrangements can be finalised. “The temporary strategy we adopted was to select external investment managers, who would manage the assets on a passive basis.” In addition, it was decided to have a fixed asset allocation for the different portfolios.
With the plan advisers, the bank established different portfolios for the flexible benefits fund. Four funds were established, a cash fund, a cash/bond/equity fund, a bond/equity fund, and an equity fund. Members of staff may choose to invest in any one or any combination of these funds. When launching the scheme the bank took care to present the advantages/disadvantages, risks/rewards associated with the various options in the context of member’s requirements from the scheme, emphasising in particular the long term nature of the scheme, and the relevance of the phasing of their career. In this context, the establishment of a lifestyle fund will probably be considered soon.
When the ECB held its selection procedure for selecting investment managers, it was looking not just to find a manager but also to see what sort of solutions the managers would propose as to whether the plan should be operated on pooled or stand alone funds, what indices they recommended, and what techniques they would use for tracking, and their tracking error record. There were also the considerations as to reporting and, of course, the question of cost, he added.
The present arrangement has just a two-year horizon. “By then, we should have the investment committee infra-structure in place. It will be the task of these committees to assess the experience to date, to make recommendations concerning the future investment strategy, and to select investment managers. “The whole scheme, he emphasised, was conditioned by the fact that the ECB will , as an international institution, be staffed by highly qualified and mobile nationals of all EU member states. The business objective of the pension scheme is therefore that it should be portable to allow not only for transfers out but also for the recruitment of staff in mid-career, flexible to allow staff to tailor their contributions to their particular circumstances as well as providing the full range of benefits for the standard long term career.
This article is based on a contribution to the Sixth European Institutional Asset Management Conference held in Frankfurt recently