Breaking the mould
The supranational nature of the EBRD is reflected in its pension plans. Fennell Betson reports
When the European Bank for Reconstruction & Development (EBRD) was set up in 1991 with the aim of helping former communist countries in Europe to restructure as market economies, it was established as an international organisation, with the agreement of 60 shareholders consisting mainly of countries and two supranationals – the EC and EIB.
That it was based in London was the outcome of political negotiation at the time, but from the staff remuneration and benefit point of view location was largely irrelevant, as the bank’s head of compensation and benefits Roger Burston explains: “Like the EC and the European Central Bank, we are outside the tax structure of the country where the headquarters are based. So our employees are not subject to external taxes on income, unless the shareholders have decreed otherwise. Only two have – the US and Czech Republic.” But the EBRD plans are not an employee’s nirvana of a tax-free remuneration zone. “In order to qualify for this exemption, we have to impose our own internal tax. Though we pay tax, it is still very much ‘an internal affair’ as the tax stays within the organisation, though for the benefit of the bank through an increase in its reserves and not the employees.”
So when recruiting, the aim is to offer a salary that is on a net basis equivalent to what would be paid locally outside the organisation. “Because of this situation, we are that bit different from the normal pension scheme arrangement, being outside the UK and any other tax rules,” says Burston. “This gives us some very necessary flexibility on account of the nature of our workforce.” The staff comes from the 58 shareholding countries, most of which are represented among the 1,000-plus staff in London. “So when devising the retirement plans, we had to put together schemes that would suit an international workforce, usually going back to their own countries when they left the bank.” Burston joined the bank just three months after inception and was very involved in developing the plans.
At the time, the defined benefit/defined contribution debate was very active and the bank’s solution was admirably simple and even-handed. “We decided to set up a plan that had a mix of both DB and DC. So the decision was that half of the benefits would come from each approach. Obviously, when a DC plan is put into place it gives no guarantee in terms of a final pension. So we set up a target benefit as staff needed this to be able to understand what these benefits meant.” The stated target was that after 30 years’ service the employee’s pension would be 70% of their gross salary. Though he notes that, with annuity rates declining generally, this target may not be so relevant any longer.
But as a gauge as to how the plan has progressed, Burston points out that the £90m (e150m) value of the scheme is split equally between each plan. “This shows perhaps that they are working in the way they were intended.”
When the bank was set up, the decision was that it would offer regular permanent contracts, but it was expected that – because of the international nature of the workforce – staff would not stay with the bank for their full career. In fact, the movement of staff to and from the bank is about the same as generally in the City of London. From a pensions perspective, the plans were designed to cope with this.
Under the DC plan, bank and the employees pay in 8% of salary each, and employees have the ability to choose from a range of funds where they want to be invested. “This plan was set up to provide a cash withdrawal benefit, so when the staff member left, whether at retirement or moving elsewhere, they could take the money to invest as they please.” The DB plan, which is entirely funded by the bank, works according to a formula that provides a capital value, taking into account salary and length of service, the idea being that it would be converted into a pension annuity, though this is only provided as a lump sum. “The bank did not want to become involved in paying a pension, as we did not want to have a pensions department, so this approach meant a clean break on leaving the organisation.” But if staff leave early, the benefits will be retained by the bank and held for them until retirement.
While the bank has aimed to be flexible when people leave, Burston says: “I felt we should be offering more flexibility to staff who were staying with the organisation. In addition, we had some discussion as to how paternalistic we should be as far as the DB element. We decided that this should also be able to be cashed in upon leaving rather than deferring benefits to retirement. As staff might be going back to their own countries and want to buy back into their state or private schemes. We felt it appropriate to give them the flexibility to do that.” Though at present it can all be taken in cash, Burston points out that this may not always be permitted. Because the bank is relatively young, an amount corresponding to the first 11 years’ service can be taken, but a close watch is being kept on the area as “we are not going to be irresponsible”.
On the DC plan, a facility was introduced to allow employees to withdraw cash to fund housing. “We thought this important as we were encouraging staff to come to very high housing cost location, but at the same time they had the assets with the bank which they could take as cash when they left. So why not utilise this while still working for us.” This can be used to purchase the main residence or to reduce a mortgage loan. Since then, this has been extended to help staff to fund ‘life matters’, such as education for themselves or children, child care or similar issues. “So we think we have retirement plans that are more than retirement plans. There is a demand for this feature and staff do utilise this option.” In addition, if staff want to contribute more to pension benefits they can do so, through an additional contribution scheme, on which they get ‘bank tax relief’ on their contributions.
Under the DC plan, the aim was to provide a reasonable mix of investments. “We have set up a range of eight equity and cash funds and we are discussing introducing a bond fund soon. We also provide a default fund for those not making an investment decision, which does have a mix of 50% sterling cash, 25% UK and 25% other overseas equities – about half of the staff decided on this for one reason or another.”
The DB plan was actively managed for the first four years of its life with an external manager, which underperformed because of the manager’s investment strategy. “We took the view that it was not the investment committee’s role to second guess the manager, nor, despite having the expertise in the bank, is it our job to make investment decisions.” So, an asset liability study and strategic investment review were undertaken with a consultant and the outcome was the decision to invest on a passive basis. “We were probably losing about 0.5% a year on the previous strategy.”
A tender was undertaken for fund managers and the same managers were retained. But the following year, the managers said they were moving to life funds, which would not be able to cope with the banks’ tax situation, so in 1998, Gartmore was chosen as the fund manager for both plans. The investment committee monitors the managers very closely and, Burston says, there are no current plans to change the arrangements. “We have been reasonably satisfied with the performance since the change.” The investment stratedy issues are handled by the committee, advised by the consultants. So the DB fund has a mix of UK, US, European and Far East equities amounting to 60%, with a 35% tranche in indexed gilts, mainly held within pooled vehicles. In addition, there is a 5% allocation to the Goldman Sachs commodity index. “Prior to the review we had a 90% equity holding.”
Since the funds started, returns of 13% a year have been achieved on the DB fund. With DC it depends on the individual funds, which scheme members can switch between, but the default fund has returned an average of 11% each year.
“On the DC side, since we have a plan that is a mix between a pensions and a savings arrangement, we have different administrative requirements compared with the usual plan in the UK. We have had some challenges there, particularly about the speed at which information becomes available, so we are looking at that.”
One key objective for Burston is to extend pension benefits to the 200 or so staff hired in the bank’s overseas offices, which are predominantly in central and eastern Europe. “When we set up these offices in these countries, it was not usual to offer pensions benefits, but now arrangements are being introduced there and we want to do the same. I would like to see if we can run it as one plan rather than having to set up a range of plans. This has to be reviewed, but it is our main focus for this year.”
Overall, he comments that what made developing the EBRD scheme so challenging and satisfying was that “we could devise a scheme that suited the organisation, and then to amend it to fit in with what we really needed”. Very few organisations have such a golden opportunity to put their plans in place free of the legal and tax constraints which usually force them into standard moulds.