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Responding to the challenges

Facing a barrage of demands from all sides, Europe's corporate pension schemes are struggling to reshape themselves in a way that is acceptable to everyone. But as lawmakers churn out pensions legislation, sponsors put the squeeze on contributions and pensioners live longer than ever before, the future of some schemes hangs in the balance.

Dealing with today's huge volume of legislation and regulation is the biggest problem for company pension schemes in the UK, says Joanne Segars, chief executive of the National Association of Pension Funds.

"The changes from the 2005 Finance and Pensions Act are quite substantial pieces of legislation," she says, adding that they require schemes to make several changes. Pension schemes have barely had time to catch their breath from this raft of administrative work before being faced with the requirements resulting from the anti-age discrimination legislation which came into effect at the beginning of October, and which schemes have to implement by December, she says.

She points out that there is also the government white paper on personal pension accounts and another state pensions bill. "The demands on trustees are really quite substantial at the moment," she says, adding that the NAPF has called on the government to lighten the burden of new legislation on pension funds.

Underfunding is still a major problem for many pension schemes in the UK, says Segars. On average, schemes were 85% funded on an FRS17 basis in 2005, and though the figures are not yet available, this percentage will have picked up a little in 2006, she says.

"But the issue is still the same, and it presents new challenges," she says. In many cases, sponsoring firms are injecting extra funds into the schemes, and this involves trustees, as it becomes their duty to ensure the strength of the employer's covenant, she says.

The burden of providing pensions has now become so great for employers that many are looking at ways of getting out of the game. "We will see more employers asking themselves what it is they want to be offering by way of retirement benefits," she says, adding that the NAPF will keep a watching brief on that trend.

Many companies have announced that they are not only closing their defined benefit (DB) schemes to new members, but also to future accruals by existing members, and these include retailer Debenhams and insurance broker Jardine Lloyd Thompson.

In the UK, new insurance company Paternoster has taken over the asset and liabilities of several pension schemes for companies keen to offload them. The man behind Paternoster is Mark Wood, the former head of Prudential's UK life assurance business.

Other companies are thought to be considering transferring their pensions assets and liabilities to this or similar firms that have been established, or to one of the other insurance companies willing to take them on.

"It's too early to say if it is a route they will go down… certainly there is an increasing interest," Segars says. Company pension schemes in the UK first need to consider the cost that would be involved in taking this option, she says. "One of the reasons they haven't done it is cost," she says.

Despite the extra burden now shouldered by pension scheme trustees, Segars says there is as yet no evidence that people are more reluctant to take on the role. Trustee vacancies are currently only running at around 2%, she says, although it is harder for schemes to find member-nominated trustees than those who are nominated by the sponsor. "One of the things we'll be monitoring is whether it will be harder to get employer-nominated trustees," she says. "It will become clearer as things start to bed down."

At the coal face, those managing Europe's corporate pensions schemes are simply getting on with the work of restructuring. At the Bank of Ireland, the key activity right now is the implementation of its group pension strategy, says Frank Flynn, head of group pensions. The new strategy addresses governance, benefits and fund structure issues, he says.

So the bank's current priorities are the launch of master trusts in Ireland and the UK which are founded on the new group pension scheme. The new scheme, which took effect on October 1, has a hybrid benefit structure combining cash balance and defined contribution, he says.

The establishment of the trusts is intended to accommodate current legacy schemes, he says. "We are also well advanced on an investment strategy, which is taking full account of the impact of the pensions liabilities on the group balance sheet under the IFRS arrangements," he says.

The pensions strategy review has been a major activity for the bank over a long period, he says, and the resulting strategy would leave it well prepared for the future.

Just how effective the strategy proves to be is key, he says. "There will be a continuous process of reviewing and updating to see if the various strands of the strategy are countering the impacts of pension fund liabilities as we go forward."

There are a lot of areas of uncertainty for many corporate pension schemes at the moment, he says, partly because of mortality improvements and
partly because of the balance sheet volatility arising from the IFRS
implementation.

This year's feverish levels of mergers and acquisitions activity has added to the challenges facing many corporate pension schemes in Europe. When workforces are restructured, retirement benefits schemes often have to bend to fit the new company shape.

At the beginning of 2006, Nokia and Siemens announced that they were merging their network telecoms businesses in a joint venture. The Nokia Pension Foundation is in the final stages of the process of converting into a scheme that will cover the Finland-based employees of the new Nokia Siemens Network.

"We will turn into a multi-employer pension scheme," says Anu Kallio, senior manager, corporate finance at Nokia, and head of the Nokia Pension Foundation. About 40% of Nokia employees will be transferring into the joint venture, she says.

All the changes need to be in place at the pension foundation by January 1, she says. "We will definitely reach that goal," she adds.

As a legally mandated scheme, issues of funding and worries about the effect of demographic changes are not really a concern, says Kallio. Because Finnish companies where there is a legally mandates scheme must, by law, provide specified benefits to their employees, the sponsoring company is obliged to make up any shortfall in funding, she says.

However, she points out that sponsoring companies do have the option of arranging pensions for staff through insurance contracts rather than having their own pension foundation.

Kristof Woutters, senior portfolio manager at Dexia Asset Management sees the main drivers of the changes happening within corporate pension schemes as the new accounting rules - IFRS/IAS19 - and the changes in the regulatory environment, largely resulting from the transposition
of the IORP directive into national legislation.

As a result, trustees now have much more accountability than was the case before, he says, and this is often cited by trustees themselves as their biggest concern. Within corporate pension scheme management, there is much more risk awareness, says Woutters. This has led to higher demand for liability-driven investment and asset-liability management services and products, he says.

While, as Woutters points out, the main effects of the introduction of IAS19 hit the sponsoring company rather than the pension fund, there might be a knock-on effect on the scheme. "Of course the investment policy of a pension fund might be influenced by the fact that sponsoring companies may wish to limit the volatility of the funding deficit or surplus," he says.

Sponsoring companies now tend to be more involved in the running of pension funds, as a result of IAS19 and the spotlight it has put on the sponsoring company, he says.

Benefits packages offered by corporate pension schemes are changing, and in many cases, becoming more flexible, says Woutters. "Pension plans are becoming more and more complex due to this added flexibility," he says. The biggest change has been the drive towards defined contribution plans, mainly caused by the increased complexity of running a defined benefit scheme, due to IAS19 and the IORP directive, he says.

The shifting legal landscape surrounding Europe's pension funds can mean that agreements put in place in the last few years have to be changed before originally envisaged.

The €674m Dutch pension fund of engineering multinational Arcadis is currently negotiating with the sponsor over the size of its contribution.

"Three years ago, we made an agreement with the sponsor about the contribution," says Armin Becker, pension fund manager at the Arcadis Nederland pension fund. The contribution is a stable one, he says, because the scheme is qualified as a collective DC (CDC).

But a new pensions law is taking effect on January 1 in the Netherlands, which defines the contribution in a different way. "At the moment, we are discussing with the sponsor if and how the contribution can be changed for the next two years," he says.

The Arcadis scheme raised its retirement age to 63 from 61 three years ago, and has no plans for any further changes, says Becker. The introduction of IAS19 was the reason the Arcadis scheme was changed to a CDC scheme, he says.

"The sponsor is very intensively involved," says Becker. It has a third of the votes on the board of the pension fund - giving it as much say as the pensioners on the one hand and the active members on the other.

In the Netherlands, the implementation of the New Financial Assessment Framework (NewFTK) is one of the main challenges for Dutch corporate pension schemes, says Erik van Dijk, chief investment officer at Dutch consultancy Compendeon. IFRS is another related issue, he says.

As well as these regulatory matters, schemes are having to cope with today's relatively low interest rates, he says, as well as having to address the need for better integration of the liability and asset sides of their activities.

Within investment, new challenges include the rise of emerging markets - which are new markets with their own return-risk profiles and liquidity issues - and the creation of new investment vehicles or even asset classes, he says.

They might offer new possibilities, but all these new products and ideas also have to be implemented and managed by the pension schemes, van Dijk points out. "We see that on the pension management side… these changes are having an impact as well. Especially the smaller plans will have difficulties solving these issues on a stand-alone basis," he says.

Along with longevity risk, these factors have made pensions more important in the sponsor's eyes, and a growing number now realise how large the impact of pension plan results will be on the corporation, says van Dijk.

"We also see that CFOs are now far more interested in the pension plans, the composition of boards of trustees, the level of professionalism, etcetera," he says.

In many cases, says van Dijk, the pension plans are far larger than their sponsoring firms, especially in countries such as the Netherlands where there is a tradition of DB schemes with strong funding.

Corporate pension plans and their sponsors are responding to the changing and more complicated environment in various ways, he says.

"One of them is a trend in which DC… is gaining in importance, although we do also feel that if, and only if, managed properly, a good DB plan is to some extent a fantastic vehicle," says van Dijk. Some say DB plans may potentially be Holland's best export products at the moment, he says, given the need for and interest in pension plan growth in Eastern Europe and some other emerging markets.

Although DB schemes are mainly run on a collective basis at the moment in the Netherlands, van Dijk sees individualised DC plans being introduced on a wider scale sooner or later.

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