Tuesday, 28 June 2011

The changing role of the Trustee as DB schemes mature

Twenty years ago the Pension Fund of which I am a Trustee had 44,315 members of which 34% were Actives, 51% Pensioners and 15% Deferred members. Today the Fund’s total membership is numerically almost identical – 44,482 - but this membership is split very differently. Only 14% are Actives, 66% are Pensioners and 20% are Deferreds. Every Pension Fund is different but the trend in mature funds away from Actives to Pensioner members, of both types, is clear. In Shell in the UK the factors included a changing business model which meant a significant reduction in labour intensive business sectors and an increasing tendency to contract out areas of the business to third parties for whom there was no Pensions liability. This trend will continue and the situation where Pensioners represent close on 90% of the total membership of the Fund is not many years away. If a Defined Benefit scheme is closed to new members or closed to future accruals for its Actives (neither is currently the case for Shell) then the significance of the Pensioner membership as a percentage of the total will increase further. What are the implications for Funds, from a Trustee perspective, of this radically changing membership composition?

Trustees of mature funds, in which the number of members receiving pensions far exceed those still working, must take account of these changes both in the “hard” aspects as well as the soft. By hard I mean issues to do principally with the sponsor’s covenant and with funding ratios. When Pensions Funds were first set up in most cases on day one of the fund’s existence 100% of the membership were Actives. Gradually, of course, this changed and at some point the fund’s annual contribution receipts (Employer and Employee contributions related to Actives) became overtaken by the outgoings – the benefits paid to Pensioners. From this point on the nature of the Fund began subtly to change. No longer was the Fund primarily a tool for attracting and retaining staff. Instead it became an increasing actual or potential burden on the sponsor – there is no need to recall here the dramatic effect this had on some famous sponsors with, in some cases, the Company’s Pension Fund turning into an albatross which imperilled the whole business! The scandal of these cases was that we are not talking about an overnight event which suddenly turned a well-funded Pensions scheme into one with a hugely negative funding ratio. What we are talking about is culpable neglect on the part of Trustees who did not see the signs of a deteriorating position, or of Sponsors who didn’t do anything about it. You can model fund membership composition changes and test this on the future financial health of the Fund in “what if” scenarios – there is no excuse for Trustees who do not insist that this happens.

The “Soft” issues to do with the change in the balance between Actives, Deferreds and Pensioners include Board composition, communications and the general perspective of the fund that Trustees should have. Pensioner members will want to be able to rely on Trustees to protect their interests – not that these are especially complicated. In essence Pensioners need reassurance that their fund is being properly managed so that the income stream on which their retirement is predicated is reliable. When changes occur – for example if schemes close their doors to new members or stop further accruals for Actives – this is a good time to reassure Pensioners that their own positions are unaltered. A practical way of showing that the Trustees understand the changing nature of the Fund would be to give Pensioners greater representation on Boards. And a mature DB scheme becomes much less an element in employee compensation, and as such a responsibility of the Sponsor’s Human Resources Department, and much more takes the character of a stand-alone investment business for ex staff providing benefits to which, of course, they are fully entitled! The relationship with the sponsor also changes in a subtle way. In the past the Pension Fund’s funding by the Sponsor was a pragmatic way of keeping employees happy. Now it is a duty and a legal obligation but without any concomitant benefits of employee loyalty or staff retention. Loyal and contended staff can add to the bottom line – loyal Pensioners make no such contribution!

Trustees have a duty of care to all of their Fund’s members and must not discriminate between the member classes. But this doesn’t mean that they should be unaware of the member composition changes that are underway – many of the priorities of a closed mature fund are likely to be very different from that of a Fund with a high proportion of Actives and which is still open to new members.

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