Chemistry of mix and match
ICI’s business philosophy is decentralisation. The company’s worldwide operations, which span some 50 countries, are divided into four business units, each of which is granted a significant degree of autonomy.
But there is one important exception. The one area in which the company is pursuing an active policy of centralisation is that of retirement benefits. In fact ICI’s worldwide pension programme does work based on a system of local autonomy but with a stiff measure of local control.
“This is due to the need to control the risk,” says David Birtwistle, ICI’s international benefits director.
The company operates local pension schemes catering for its 33,000 employees worldwide. On an international accounting standards basis its pension liabilities stand at around £8.7bn (e131 bn); pension assets are just over £1bn short of that figure. The market capitalisation of the company is around £3.5bn. So the risk is not insignificant.
The deficit relates partly to unfunded overseas pension arrangements, including book reserves in Germany and top-up book reserves and post-retirement healthcare in the US. Unfunded pension and healthcare benefits account for around one third of the deficit; a further third is in the main UK fund and other funded arrangements in other countries make up the rest.
To close the funding gap, ICI is paying an additional £62m per year into its UK fund. The company has also put in place an insolvency guarantee so that, in the unlikely event of the company going bankrupt, trustees of the UK fund would have access to £250m. “This is our own mini-pension protection fund,” says Birtwistle.
Furthermore, the guarantee fund has been assigned the status of senior creditor so that the scheme members would have first call on the assets.
The company is not asking scheme members to contribute towards closing the deficit; the trust deed of the UK scheme doesn’t allow it. Birtwistle explains: “The trust deed was drawn up very restrictively so there cannot be any worsening of conditions: reduction of benefits or increase in contributions.”
But there is also a smaller, defined benefit (DB) fund in the UK,
and one in the Netherlands where this rule doesn’t exist. “In those countries we cannot rule out seeking extra contributions from members in order to help provide the benefits promised,” he says.
A defined contribution (DC) scheme in the UK was introduced in 2000 when the DB funds were closed to new members. “This was done to reduce risk, not cost,” Birtwistle continues. “And we want to introduce greater certainty in pension costs. We would rather contribute 15% each year than 10% one year and 20% the next.”
The DC philosophy has been rolled out worldwide in the past two to three years, all with a view to reduce the risk to the company. Countries where the DC policy has been implemented include the US and Canada. “We may not go that far in the Netherlands because of the culture of pensions solidarity,” says Birtwistle. “There are similar issues in Belgium but the plan is in surplus so there is not the same risk pressure.”
The company has adopted a policy to leave existing members as they are and just to introduce new plans for new employees. “However, in the Netherlands the unions insist that any new arrangements should apply across the board – for all members,” says a frustrated Birtwistle.
In some cases, where progress in switching to DC has been slower than anticipated, the company makes a point of showing the local operations how they might make the move sooner than they might if they were left to their own devices. The US pension scheme is a case in point.
To date the company’s DC philosophy has been its main message to its local country businesses. Birtwistle: “We focus on those countries where there are the most employees or where progress has been slower than had been hoped, because of a regulatory setup that has not been conducive.”
Other countries where moves to change are unlikely include France and Italy, which have arrangements imposed by the state. France’s mandatory supplementary pension schemes are an example. Birtwistle is not impressed with these structures. “I believe that multi-employer pay-as-you go schemes are not sustainable in the long term,” he says. “They will only work if both the economy and population are growing.”
The company provides a range of investment choices for the members of its DC schemes; fund performance is monitored by the fiduciaries. In the UK a lifestyle fund is used as the default option.
Investment choice means that scheme members will need education. Birtwistle explains: “The company aims to educate its workforce in pension matters with the aim of promoting more informed choice of investment option and less falling into the default option.”
As well as driving the move to DC, the reduction of risk has also been central to the company’s asset allocation policy. Between 1997 and 2003 the UK fund moved heavily into bonds with a view to matching the assets in what was becoming an increasingly mature fund. Like other companies the ICI fund was previously heavily invested in equities.
More recently the fund started investing in high yield debt and emerging market bonds. Birtwistle says: “The trustee view is that we should continue to diversify the portfolio with a view to achieving the minimum risk combined with a reasonable return.”
He adds: “Our investment strategy is to minimise downside risk. Of course this limits the upside potential, so we are accepting the fact that we have to make additional contributions. We have pushed this message out to the local businesses but are concentrating on the UK where the bulk of the risk lies. In the Netherlands the regulator has helped determine where we are in terms of investment strategy.”
For governance purposes the company divides the local country plans into two groups. “There are those in which we take a close interest,” says Birtwistle: “These are the UK, US, the Netherlands, Canada, Germany and Belgium; these plans have the largest liabilities and hence the largest risk exposure. They are also countries where we have DB risk exposure.”
In other countries the company has what he terms a “watching brief”.
This means that it allows the local businesses to run the schemes autonomously but does not permit them to make any change to their plans without approval by the head office governance committee. “Any significant changes to the investment strategy, the benefit structures or the actuarial provider would require approval from head office,” he says. Head office maintains contact with four regional HR networks to monitor these smaller plans.
The governance committee is headed by the CFO and includes the executive vice president of human resources, group treasurer, the international benefits director, the corporate investment officer, and the CFO of the US operation, which represents ICI’s second largest pension liability.
The choice of the asset manager is the responsibility of the trustee. “We do not stipulate that local businesses use this or that asset manager,” says Birtwistle. “That would not be right. We have confidence that the local operations are able to make good decisions. This is the case especially with the larger operations, which is where there is the most concern about risk.”
He adds: “The local trustees are very well educated in financial and investment matters, and all work closely with the corporate investment team at head office.”
The corporate investment officer sits on the local trustee boards or acts as an adviser. He shares best practice with them in terms of asset management and investment strategy.
If a local business wants to change asset manager the company looks to see if that asset manager is used elsewhere in the worldwide operations. “Where we think we can add value through leveraging of scale we will encourage the local fiduciaries to do so,” Birtwistle explains.
Asset pooling is not under consideration at present. The main reason for this is that by far the largest part of worldwide pension assets, some 85%, sits in the UK fund. “So the assets are already pooled to a great degree and we don’t see any significant savings at present by bringing in another 5%,” says Birtwistle.
Pension assets in the Netherlands, US, Belgium and Canada together account for a further 12% of pension assets. “Sometime in the future we might have a Europe-wide DC scheme,” says Birtwistle. “With a simplification to the UK system due next year that allows UK schemes to include foreign employees we could have a Europe-wide plan here in the UK.”
But some countries may prove problematic: “Whatever we did in the Netherlands we would still need union agreement,” he says. “So I don’t think a Europe-wide plan would help here,” he says.
In terms of the level of pension benefit to be provided, the company works on a clear principle. “We want to be in the game of pension benefits and so need to provide a competitive offering which we set at the industry median in each country, Birtwistle explains. “We do not believe that an above-average pension would help us to attract and retain talent. We would rather incentivise our staff in other ways.”