Though the Philips Group as a worldwide electronics company operating in over 60 countries worldwide has a total workforce of 166,500 employees, it currently does not have any multinational pension plans.
The pension plans the group has across the globe were established as the company grew its activities over the past 110 years. “Basically, they were locally set up when needed,” Gabriel van de Luitgaarden, chief financial officer of Schootse Poort said, when addressing a recent IPE Multipensions seminar in Amsterdam.
Schootse Poort, which is as a wholly owned subsidiary of Philips, had its origins in the group’s Dutch pension fund where it acts as the asset manager and pension benefits administrator.
But all pension funds in the group are locally managed and to a large extent have operated independently. “In the past, this has meant that the company has not had final control over such questions as the actuaries to be used, the actuarial standards to be utilised in valuing liabilities, selection of asset managers and investment strategy, particularly how strategy was set up and linked to the structure of the liabilities.”
In the past, there have been occasions when the group’s board of management was faced with surprises. “Though there were no major surprises, even small ones are very unwelcome,” he said. “This resulted in Philips facing unexpected cash flows into pension funds in several countries, with an impact on the group’s profit and loss.”
Globally, the group has approximately 15 pension funds, which is certainly less than many other multinationals, he reckoned. At the end of 2002, the total assets came to E18bn, but three funds account for some 80% of assets and liabilities. The Dutch fund is responsible for 60% of total assets, which also explains why the majority of pension liabilities are defined benefit and not defined contribution.
“The Dutch fund has dominated the group’s approach to pensions over the past 10 years, especially during the years 1996 to 2001, where the fund contributed significantly to the bottom line of the company.” In addition to premium holidays, there had been cash refunds.
Nonetheless, because of the surprises that came up from some of the local pension funds, group management determined to get a closer grip on the local pension funds some years ago. A corporate pension office was set up said van de Luitgaarden.
“It introduced a number of corporate policies on pensions, for example, on how to select custodians and investment managers. But local pension funds were still able to run their own affairs.” Corporate Pensions did draw up an inventory of the local pension schemes, how they were funded and what liabilities they had. “This certainly helped to give group management the full picture.”
The past two to three years have shown that pensions are very much a liability. “Now the conclusion is that pensions are a substantial liability and one that needs to be controlled very well.”
There has been serious rethinking of the question of providing pensions at all, and if so, how the costs can be controlled and minimised. “In our view at the moment, the key questions are the contributions that need to be put in and the risks of future funding shortfalls to the employer.” While the running cost of the plans is always an issue, compared to the impact of volatility of the assets and the liabilities, this is minimal, he pointed out.
The main focus of the group is to control exposure to risk coming from its pensions obligations. “While the corporate pensions office was a good initiative, it was not sufficient. Now a pensions policy board has been set up, chaired by the group chief financial officer, who is taking direct responsibility for pensions as a whole.”
While this board convenes only four times a year, it is what lies behind it that is important. “This is where Schootse Poort comes in,” says van de Luitgaarden.
The board is introducing a global risk reward strategy. “What we want to do is to obtain a clear idea of how the structure of the balance sheet of the company is affected by pension funding. In particular, what type of risk is introduced into the balance sheet and P&L, just by having a pension plan and its related investment strategy.
“What comes out is that for instance it introduces a potential risk to the credit rating of the company. Our objective is to see how we can control these risks at a pension funds level or at a group level.”
One obvious approach, he noted is to change pension plans benefits and structures. “In a Dutch context, it is unrealistic to move entirely from a DB to a DC scheme, so we are making the move from a final pay to an average pay plan and this is something which has been under way since 1997.” On the inflation risk aspect, the protection of benefits in payment from inflation has been another area of concern. “Here substantial negotiations with unions have been in progress on limiting the impact of this inflation risk.” In other countries, DC plans have been more common and any new arrangements being introduced will be on this basis.
The group is now on top of the global pensions funding issues. “We are developing standards for asset liability management and risk analysis. At the moment we are looking at the investment strategies of every pension fund and trying to recognise consistency in strategy for each fund.”
So there is a substantial amount for the pensions policy board to handle. Because of these pressures, the role of Schootse Poort has evolved outside the Dutch pension fund, becoming a ‘Pensions Competence Centre’. “What we mean by this is an organisation with a lot of experience and knowledge about pensions and asset management. We are certainly not trying to run pension funds out of the Netherlands, but we are trying to combine and share knowledge and to capitalise on existing systems and experience.”
In addition, the different group pension funds worldwide are being encouraged to move to a benchmark insensitive strategy. “This is not an easy thing to do, as there is significant confusion in the market about what absolute return driven investing means.” A global actuary has been introduced for Philips with the objective of obtaining consistent valuations and reporting of liabilities. It also provides a good starting point for any ALM studies.
“We have also introduced global custody to ensure we obtain consistent valuations of assets, consistent performance measurement and ‘head office reporting’ services. This will enable us to get a good picture of where the different pension funds are.” In addition there is a global strategy for hiring, firing and monitoring asset managers.
For Philips, these are the questions that are on top of the agenda at the moment. “Pooled investment vehicles, pan-European pension funds and so on can be very attractive, but they are not a top priority currently. Our main concern is how to control risks.” The gains on the costs side are not to be ignored, he said, but the concept of a pan-European pension fund is still too far off. “When you look at Europe, there still is so much regulated locally such as tax and other rules, that it is very difficult to merge all that together into one all-encompassing pension plan for Europe.” Philips believes it can achieve much the same objectives by making sure local pension funds do not enter into liabilities that the group does not want them to. “Strict controls over the liabilities and well designed and applied investment strategy will take us there,” says van de Luitgaarden.