Deficit addressed without sacrifice of DB principles
Pension fund deficits have led to increasing pressure for the funds themselves to switch from a defined benefit (DB) to a defined contribution (DC) basis - and this generally means reduced benefits for scheme members.
Like many other British DB schemes, the BAE Systems Pension Scheme faced the challenge of a substantial actuarial deficit, estimated at €3.6bn, compared with its total assets of €7.6bn.
But unlike many of its peers, BAE Systems has withstood the temptation to switch to a DC structure. Instead, it has addressed the deficit in an innovative way that allows the DB scheme to remain open to current and new employees.
It is this determination to maintain the best possible benefits for members, and its success in achieving this, that has won BAE Systems the DB/DC structuring and strategies award.
What underpinned the fund’s approach to tackling the deficit were genuine moves to involve its members fully in planning the changes to the scheme. The philosophy was that the pain of the deficit would need to be borne jointly by the employees and the company, and so a full consultation exercise was an integral part of that.
The BAE Systems Main Scheme 2005 valuation result had been announced to members in August 2005. The following month, the company embarked on a substantial communication and consultation programme to help develop a series of cost-saving measures applicable to post-April 2006 service only.
These measures include the longer averaging of pensionable salary from one to three years, which is expected to save €136m.
Another step is the application of a variable longevity adjustment factor, in order to reflect ongoing changes in mortality expectation, resulting in estimated savings of €208m.
A further €225m should be saved by capping pension increases at 2.5% a year, instead of 5% as previously. Early retirement terms will be adjusted to make them cost-neutral, to save around €30m.
There will be an increase in employer contribution rates, as well as a substantial once-only employer contribution of €525m. Finally, a SMART salary sacrifice arrangement will be introduced in order to save national insurance contributions being paid to the pension scheme. This is expected to contribute €150m.
In order both to seek members’ views on the proposed arrangements and to keep them fully briefed, BAE Systems Pension Scheme sent out detailed written updates - six in all - to active members. It also set up a dedicated pensions helpline, supported by the pensions policy team, which answered many hundreds of individual enquiries. Three sets of frequently asked questions (FAQs) were published on the BAE Pensions website.
In addition, a benefit modeller was set up on the pensions intranet, so that members could use the information from their previous benefit statement to work out how they would be affected by the longevity adjustment factor and salary averaging.
In January 2006, all active employees who were members of the BAE Systems Pension Scheme were given onsite briefings about the company’s final proposal, and were individually invited to take part in the company telephone and internet survey to indicate whether or not they agreed with the company’s final proposals.
Each employee was issued with an individual PIN number to enable them to vote, and to prevent multiple voting. Trades union members were also invited as individuals to vote through a trades union consultative ballot.
The result as a whole showed that an overwhelming majority of members were in favour of the changes. The telephone/internet ballot showed 88.2% of the total 14,672 votes to be in favour, while 71.8% of the 10,818 voters in the union’s consultative ballot said “Yes”.
The innovative nature of the pension fund restructuring was reflected by the press coverage which followed the announcement of the changes in June 2006.
Dan Roberts in the Financial Times on 14 June 2006 said: “For a lesson in less confrontational employment practices, look no further than the friendly local arms dealer”. The same day, the Financial Times itself also referred to BAE’s “groundbreaking plan to fund the actuarial deficit”.
And Damian Reece, city editor of the Daily Telegraph, said: “Other companies and their workforces should take note of how it can be done.”
In total, the changes to benefits are expected to save €840m, while additional company contributions will add €1,264m to the pension fund’s assets.
As a means of tackling a substantial deficit, with employee endorsement, BAE has provided a new and innovative way forward. The changes have allowed its final salary arrangement to remain open on a much firmer footing for current and new employees.
Highlights and achievements
BAE Systems Pension Scheme has shown itself to be that rarest of breeds: a pension fund which is successfully addressing a serious deficit while keeping intact the principle of defined benefits. Furthermore, at all stages of the process, the fund has consulted its members, as well as keeping them informed on progress. Members were briefed by written updates and access to a pensions helpline. They then voted by phone and internet, and a special union ballot was also carried out. In both cases, there was an overwhelming majority in favour of the changes. The package of cost-cutting measures applies to service beyond the cut-off date of April 2006. They include longer averaging for pensionable salary, the application of a variable longevity adjustment factor, a lower cap on pension increases, and an increase in employer contribution rates. The changes to benefits are expected to save €840m, while additional company contributions will add €1,264m to the pension fund’s assets.