Deutsche Shell explains to Fennell Betson how it’s done
At Deutsche Shell in Hamburg, they reckon they have gone as close as they can to setting up a German pension arrangement, which functions much as its equivalents in the Netherlands or the UK.
Treasurer Jens-Peter Stoehr explains that before taking this step, the company had around DM2bn (e1.02bn) of pensions liabilities covered under the book reserve system, which German companies use as the most tax efficient and administratively lean way available to them of meeting their pension commitments. The assets of the company are there to meet these liabilities and additionally, the industry-wide insurance solvency scheme is in place to cover the bankruptcy risk, which happened when industrial group AEG crashed in the mid-1980s.
“But in the eyes of ‘Anglo-Saxon’ analysts, these are unfunded liabilities,” says Stoehr. His treasury colleague Holger Stemmler, who is also involved in running the scheme, adds that none of the usual ways of setting up a funded scheme within Germany appealed to them on the grounds of cost and being cumbersome to run. “In addition, to finding something that would allow us to invest our liquidity more profitably, we wanted to find a way that, on the one hand, would have in place all the fiscal regulatory and reporting structures needed in Germany and on the other hand, qualify under FAS87 as a funded pension plan.”
Another consideration, which Stoehr describes as the ‘human resources dimension’, was the desire to put German beneficiaries in a similar position to Shell employees elsewhere where funded schemes are prevalent. “German staff are now treated equally with those in other countries.”
There are three FAS87 requirements for a funded pension plan, according to Stoehr: “The first is that you put your assets in some form of trust, and secondly, that these can be separated from the assets of the company. Thirdly, these assets must irrevocably be restricted to the payment of the pension benefits.”
In 1997, the company found the route to this goal, by setting up a vehicle that is similar to, but not quite the same as a trust under English law. Deutsche Shell Pensions Trust is in fact a registered association, with 11 members. “The key thing is that it has a legal existence independent of Deutsche Shell.”
An agreement is drawn up between it and the sponsoring employer. On the basis of this, Deutsche Shell transferred DM2bn, accomplishing the first step of segregating the assets from the rest of the company’s. The next step was to make the whole structure irrevocable. Stoehr explains: “This was the lien contract between the association, on behalf of the pensions beneficiaries”. How it works is that although there are legal circumstances when the assets could revert to the company, “we have put a lien in place in favour of the pension beneficiaries so that the assets cannot be returned to the company”. In effect, this means that it would not be until the last payment had been made to the final pensioners, perhaps in 70 or 80 years’ time, that any surplus would be returned to Deutsche Shell.
Compared with other methods of ring-fencing corporate assets destined for pension payment, such as a Pensionskasse or support fund, this is much simpler and less expensive, says Stemmler. It was all done in-house, apart from external, legal advice, in the course of the group’s corporate treasury activities. “The overall costs both internal and external came to only around DM250,000,” he says.
When setting up the investment strategy, the company made full use of the resources of the Shell group, by tapping into Shell Pensions Management Services(SPMS) in London, which advises schemes within the group on investment related and other issues, as well as providing investment management services.
As with other German investors, Deutsche Shell opted for the Spezialfonds route. “These are the most tax efficient way of holding the assets, as all the capital gains stay in the funds tax exempt”, he says. In order not to have all their eggs in one basket, the decision was taken to use two the asset management arms of Deutsche Bank and Dresdner Bank as Spezialfonds managers, but to go the sub-advisory route. “We have two sub-advisers, one for each fund. The first is the sister fund Shell Pensioen Fonds Beheer in the Hague and the other is SPMS in London.”
The mandates are all balanced, with a 50/50 equity and bonds split. In each of the two funds, one manager looks after a European mandate and the other a world ex-Europe brief. All are actively managed, except for one of the world ex-Europe mandates, which is run on an indexed basis. “This combination of three active and one passive managers might seem to be an unusual way of organising things, but we wanted to get a feel for how active and passive managers perform”, says Stemmler, adding: “It is a sort of internal competition”.
All four managers report to one custodian, one of the US global groups, which runs the whole accounting, reporting and evaluation aspects. “Comparing the investment managers is quite easy, as a consequence”, says Stoehr. “We are quite pleased with the performances of all the managers so far and have no reasons for complaining.” In fact the assets have grown to over DM2.4bn since start in 1997.
He regards the scheme as being more a pension plan, rather than a pension fund in the Dutch or UK sense, mainly because there is not a direct connection to the liabilities, which still remain the responsibility of Deutsche Shell and are not transferred to the fund. “We could have done an asset liability study, but decided against this as there was not such a direct link between them, so we do not have all the liquidity in the trust. As the assets are there to pay pensions, we will look at the cash flows as well, but there are no cash constraints at present. Another bit of freedom we have, is that we can think of paying pensions out of the pension assets or alternatively the company could pay them, which gives us additional flexibility.”
The investment committee is a group within the sponsor, which includes the financial director, an SPMS representative, as well as Stoehr, who says: “This essentially sets the investment guidelines”. But he is a member of the association, heads its administration board and talks to the banks’ Kags that run the Spezialfonds for the trust. “By having just one person act in this way, it is easy to keep within the investment guidelines and that enables the company to influence the investment. But that does not take away or interfere with the responsibility of the trust to fulfil its obligations to pension beneficiaries”, he says.
The company has only made one transfer of assets to the trust and does not make any ongoing regular contributions, but says it is considering making a further allocation in the future.
Stemmler points out that in terms of US GAP accounting, the company has its pensions liabilities fully secured by pension assets. “This means that assets and liabilities can be netted off from a balance sheet point of view, so you have a ‘shortening’ of the balance sheet. As a part of Royal Dutch Shell having a better quality balance sheet with less to show in terms of unfunded liabilities, gives us a better competitive edge and a better financial image in the eyes of the financial analysts. “In the analysts’ view, companies are better off with these assets in the markets, with a wider risk spread than just having the cash in the company”, he adds. This argument has been reinforced by the decline in returns available from cash to below the 6% discount rate used for pension liabilities by corporates.
There has been much interest from other German groups in what Deutsche Shell has been doing. “But to our knowledge, no other company has followed us”, says Stoehr. “The reason is that you do lose control of those assets and you cannot use them for another purpose, such as an acquisition. Many companies have real difficulty with this. At the same time, they want to go for US quotations, but if they do not segregate the assets and net off their liabilities, they will have a balance sheet problem with GAP.”
He acknowledges there are many groups for which their solution would not be suitable for in any respect. However for his own group, Stoehr gives the approach an unqualified thumbs up: “It has been a great success for us, and not just because the assets have performed well”. But he would be the first to agree that this helps.