In the light of the economic crisis, pensions are now very much a boardroom

Transcription

1 The Journal of Superannuation Management 1 Asset Pooling Comes of Age A Roadmap to Pooling Pension Assets By Alexander van Ittersum AEGON Global Pensions Alexander van Ittersum joined AEGON Global Pensions in February 2008 as product development manager for asset pooling, based in The Hague. He holds an MA in Business Economics from the University of Groningen and an MBA from the NIMBAS Graduate School of Management in Utrecht and Bradford. Prior to joining AEGON Global Pensions, van Ittersum worked for six years with Robeco Asset Management as senior product manager responsible for the institutional fund range and later for the fixed income product range. Before Robeco, he worked for Euronext as relationship manager. In the light of the economic crisis, pensions are now very much a boardroom issue, with CFOs looking to reduce pension risks 1 and to control costs. For companies with pension plans in multiple countries, this is no easy undertaking. Due to the diversity of international pension regulations, companies have to run separate pension plans for every country in which they operate. This makes it difficult for them to gain a clear overview of their pension assets and liabilities (increasing risk) and to take advantage of their international scale (increasing costs). In order to address these issues, a number of solutions have been developed in order to help companies to improve their international pensions management. Over the past few years, as several large multinational companies set up tailor-made asset pooling solutions, it looked as if asset pooling for pensions was about to break through as a must-have solution for all companies with multiple pension plans in Europe. Then, as media attention shifted to IORPs (Institutions for Occupational Retirement Provision) the new hope for European pension consolidation and the financial crisis forced companies to focus on more urgent problems, attention for asset pooling waned. However, as it has become clear that IORPs are presently of limited use and multi-client asset-pooling has become available, asset pooling is now entering a new phase as it opens up a range of benefits for companies of all sizes. No longer a solution for the few The pooling of pension assets clearly offers sponsoring companies and their pension funds distinct benefits. In practice, however, the technical difficulties of designing a robust and effective asset pooling solution have meant that only the largest of multinational companies (Unilever, Shell and Nestlé) have started to pool their pension assets. Smaller and medium-sized multinationals have not been able to benefit from asset pooling, as it does not make financial sense for them to invest in designing and implementing their own bespoke solution. Until now, therefore, the hype around asset pooling has not yet solidified into gains for companies other than the largest multinationals. However, asset pooling is now coming of age, as new off the shelf multi-client solutions are ready to place asset pooling within the reach of all sizes of international company.

2 2 The Journal of Superannuation Management In this AEGON Global Pensions white paper, we examine the issues that multinational companies face in managing their pensions and introduce asset pooling. Having discussed the diversity of pensions and pensions systems in Europe today, we explore the different pooling solutions available and show how multi-client asset pooling now offers a robust and future-ready solution for companies of all sizes. Finally, we provide five brief guidelines on how companies can implement asset pooling. Asset pooling benefits now available to international companies of all sizes The need to simplify pensions management As companies grow over time, it is not unusual for them to gain additional pension plans through mergers, acquisitions and the creation of new subsidiaries. Historically, many companies have allowed their pension plans to proliferate with little thought for harmonisation. This in turn leads to increased complexity in pensions management and increased risk. A combination of the economic crisis and tightening international regulations (for example, IFRS) have led companies to look once more at their pensions in a drive to reduce risk, increase control and decrease costs. When pension plans are managed individually, country by country, it is usual for the trustees of individual pension plans to decide on their investment policies and to choose their own investment managers. This can result in inefficiencies, hidden risks, inconsistent reporting and opaque costing (that can amount to 15 per cent of the risk premium). 2 Asset pooling offers multinational companies the possibility of optimising their pension management, delivering benefits to all stakeholders. By pooling their pension assets from different countries, multinational companies can improve their pension governance, better control their financial risk, increase their operational efficiency and obtain access to better investment solutions. Asset pooling enables companies to remove investment management inefficiencies, helping them to manage their pensions better and more cost-effectively. 2. Managing risk Knowing your risk is the first step to managing it. Conversely, not knowing what you have in your pension funds or where you have it is a considerable risk for a sponsoring company. An asset pooling platform provides a fast and consistent way to gain an overview of investment risk on both a consolidated and plan basis. Asset pooling enables companies to take advantage of a controlled investment manager selection process with ongoing monitoring, offering complete transparency and reducing risk. 3. Reducing costs For smaller companies, economies of scale mean that asset pooling provides them with large savings on their investment management fees. As larger companies often possess larger, more efficient pension plans, combining these large plans will not always result in such significant savings on asset management fees. In addition to investment management savings, however, asset pooling also offers savings on internal monitoring costs and consultancy (with a single global investment consultant instead of multiple different consultants). 4. Providing benefits for all stakeholders Asset pooling not only provides the CFO with the means to gain better control over the company s pensions but it also delivers benefits to the other pension stakeholders. The individuals responsible for the management of the individual pension funds, can be assured of a high quality and well managed investment solution for their particular pension plan. Although local pension fund trustees may be hesitant to give up their freedom to choose their own investment strategy, in return they gain access to the best investment managers and to greater diversification at a lower cost enabling them to focus on achieving optimal asset allocation for their local plan and on other important areas such as communication to the members. Figure 1. Benefits of asset pooling for all stakeholders The benefits of asset pooling Asset pooling offers companies benefits in three major areas: improving governance and control (and reducing complexity), providing insight into risk (allowing companies to control risk more effectively), and enabling companies to control their costs. Finally, asset pooling provides benefits to all stakeholders a key factor in successfully implementing any solution. 1. Improved governance and control The most important reason for multi-national companies to consider asset pooling is to improve their international pension governance. The economic crisis has revealed the potential risk that pensions represent to the corporate balance sheet. Asset pooling offers a unified investment solution with centralised reporting, providing CFOs with better insight into potential investment risks and decreasing the complexity of their pension reporting.

3 The Journal of Superannuation Management 3 Figure 2. Unified investment management Why the delay? Considering the benefits that asset pooling promises, it is perhaps surprising that it has not been adopted more quickly. As usual, the devil lies in the detail. Using non tax transparent or opaque investment funds (such as Luxembourg-based SICAV funds) is relatively simple but can lead to substantial underperformance (particularly for equity funds), greatly reducing or even eradicating the potential benefits of asset pooling. In order for asset pooling to be effective, it is important that the solution be tax efficient and developing a taxefficient solution is complex and time consuming. However, with the development of tax efficient multi-client asset pooling, companies can now benefit from asset pooling without having to develop a bespoke solution themselves. This figure demonstrates how asset pooling unifies investment management for the pensions of a multinational company, catering for a wide variety of different pensions including a Defined Benefit plan (DB) provided by a self administered pension fund, a trust-based Defined Contribution (DC) plan and a unit-linked DC plan as part of a life-cycle solution provided by an insurer (Pension Plan C). Diversity in pensions a united Europe? Within Europe, no single state pension system is the same as another. As a result, it is difficult for multinational companies to provide a unified pension solution for all of their European subsidiaries. When a company takes inventory of its pension plans in various countries across Europe, it becomes rapidly clear that there is still a wide variety in pension systems and practices across Europe. The differences apparent are the result of the different state pensions, different pension vehicles and different pension promises made (notwithstanding the different terminology used in each country). When looking at European pensions, the major differences between the various country systems lie with the state pension (first pillar). Although all European countries provide a minimal state pension, the importance of this provision varies substantially. For example, in France, Germany, Spain and Italy, the state pension presently provides the majority of retirement income. In countries such as the UK, Ireland, the Netherlands and Switzerland, occupational pensions (the second pillar) are much more important. Figure 3 includes all premiums paid to insurers, pension funds and banks for pension savings and all contributions made by employers and employees into the social security system. Figure 3. Shares of the three pillars in the total premium income Source: CEA Statistics No 28, September

4 4 The Journal of Superannuation Management Managing your pension plans It is easier for companies to exercise control of their pension plans in countries where insurance and book reserves dominate as opposed to countries where autonomous pension plans are the norm. In the UK, Ireland and Switzerland, self-administered pension funds are the primary vehicle for providing pensions to employees. In Denmark and Sweden, insurance contracts dominate the market, while in Germany and Austria, book reserves (that is reserves held on the balance sheet of the company) are the main vehicle used to provide occupational plans. Any solution that involves combining different pension plans must therefore satisfy the independent pension fund trustees as well as the board of the sponsoring company itself. Diversity of pension systems: organisation of occupational pension plans Figure 4 demonstrates the diversity of the various national pension systems, showing the different vehicles employed for occupational pensions across Europe. Figure 4. Financial vehicles used for occupational pension funds Source: Pension Markets in Focus: November 2007, Issue 4 OECD 2007 Figure 5. The full spectrum of pension plan Source: Oxera 4 Table 1. An example of the various different pension plans a single multinational company could have within Europe

5 The Journal of Superannuation Management 5 Different countries, different pension promises Another element of the diversity of the pension systems in Europe that any unifying solution has to be able to address is the different types of pension promises made to employees in each country. This refers not only to the differences between DB and DC pension plans but also to different interpretations of these systems in each country. For example, in Switzerland DC is more a cash balance system with employees having no investment freedom and the employer/occupational pension fund having to guarantee the paid-in premiums. This is very different from contractual DC plans in the UK, where the employee has complete investment freedom and no guarantees. The different types of pension promises within Europe were mapped out by Oxera in Figure 5, ranging from pure DB via hybrid plans to pure DC. Many ways to pool your pensions Given the diversity of pensions and pension systems across Europe, it is unsurprising that different methods have been developed to try to improve pensions management across Europe (and beyond). If we look at the solutions presently on offer, there is a variety of pooling solutions available, ranging from administrative and data pooling through to IORPs. Figure 6 highlights the benefits of the different solutions compared with how easily they can be implemented. Although IORPS ultimately promise the greatest benefits, they are presently difficult to implement and it will be some time before they can achieve their full potential. At the other end of the spectrum, global custody, and administrative and data pooling offer more limited benefits but require less effort to implement. Asset pooling, however, provides considerably more benefits, and, while bespoke asset pooling is only feasible for the largest multinational companies, multi-client asset pooling offers companies of all sizes the possibility to realise significant efficiency gains, is easier to implement and is future-ready for inclusion into an IORP solution, if required. Administrative and data pooling interim solutions Several multinational companies, including Mars and Reckitt Benckiser, have implemented data and administrative pooling solutions (also referred to as investment or portfolio accounting). This involves centralising pension management, including the management of pension assets without actually pooling the assets into a single investment vehicle. Administrative pooling requires internal organisational changes, such as setting up asset management committees for hiring managers. The pension assets remain invested within their present legal vehicles and pooling is only carried out at an administrative level. Administrative pooling offers some but not all of the benefits of asset pooling and can be used as a first step towards full asset pooling. Global custody a partial solution for larger multinationals Global custody offers primarily larger companies a way to lower their costs and pool the reporting of their pension plan assets by placing the custody of their pension assets with a single provider. However, global custody does not automatically lead to unified reporting and implementation nor even necessarily to improved investment management. In particular, it does not provide the additional controls and efficiency gains in investment management that are made possible by asset pooling. In addition, although companies should be able to benefit from some efficiency gains, the scale of the provider involved may reduce the negotiating power of all but the largest companies. Multi-client asset pooling Multi-client asset pooling provides companies of all sizes with the ability to pool their pension assets and to receive consolidated reporting on their assets. Asset pooling can help companies to improve the management of their pension investments, generates efficiencies and makes it easier for companies to control their pension plans. Multi-client asset pooling offers most of the benefits of bespoke asset pooling solutions but, because companies can participate in pre-existing asset pools, it is easier, quicker and less expensive to implement. Figure 6. Comparison of added value and ease of implementation of different pooling solutions

6 6 The Journal of Superannuation Management Bespoke asset pooling solutions The earliest asset pooling solutions were tailor-made solutions created for the largest multinationals (for example, Nestlé and Unilever). These tailor-made solutions can require enormous investment in time and resources. As one of the people involved in a bespoke asset pooling project said: Murphy s law will definitely strike more than once. Such one-off solutions are simply not affordable for smaller companies, which is one of the reasons why asset pooling has been slow to be adopted. Creating bespoke asset pooling solutions can be difficult and complicated, and the costs can be substantial, which is why the only companies that have adopted them tend to have more than ten billion euro in assets. IORPs under development Cross-border IORPs, like asset pooling, appear to have experienced their share of attention, as they offer the potential for true pan-european pension provision. IORPs will eventually provide companies with the ability to pool both their European pension assets and liabilities. At present, however, IORPs remain largely elusive, as differing social, labour and tax laws through Europe remain a considerable barrier to their use (and will remain so for the foreseeable future). Although the benefits of pan-european pension pooling are clear, pension benefit systems (like other labour arrangements) within the European Union are not yet harmoniszed, which has significant impact on attempts to consolidate pensions. It is for this reason that early attempts to create IORPs (and more than 70 cross-border IORPs now exist) have concentrated on countries with similar pension structures, such as Ireland and the UK. At present, such IORPs typically contain DC plans for expats or executives, as pension plans within an IORP still have to adhere to local tax, social and labour laws. As a result, member administration is still complex and efficiencies are not easily accomplished. Asset pooling and IORPs Although IORPs will eventually offer an overarching pension solution within Europe, considerable further developments in European harmonisation are necessary before these can be truly realised. There are immense obstacles to be overcome before IORPs can achieve their full potential. In the meantime, standalone asset pooling solutions provide an achievable first step towards pan-european pensions, future ready for inclusion into one or more IORPs at a later date, if required. In addition, asset pooling solutions can also be used to pool non-european assets, for example pensions assets from US, Asian or other pension funds. Multi-client asset pooling the advantages of a readymade solution Asset pooling in practice one size fits all? Although the benefits of asset pooling may be clear, creating a crossborder asset pooling solution for the first time is a difficult process requiring considerable international expertise. In order to be able to cope with the immense diversity 5 of pensions across Europe, asset pooling solutions need to be flexible and ready for change. The variety of potential and partial solutions presently on offer may have made it difficult for companies to decide which solution may be appropriate for them. With the development of multi-client asset pooling, companies no longer need to design their own solutions and instead have access to a ready-made solution at a fraction of the cost. As a result, asset pooling is now within the reach of all sizes of companies. Multi-client asset pooling can be offered either tied to a specific pension provider or as a separate solution. A separate solution naturally provides more flexibility, and may facilitate companies wishing to implement asset pooling in phases. Multi-client asset pooling platforms provide companies with access to a ready-made pooling platform, removing the barrier of expensive start-up costs and enabling companies to benefit immediately from economies of scale. When asset pooling for pensions, it is very important that the investment vehicles used are as efficient as possible from a taxation perspective. At present, tax efficient investment vehicles are currently available from Luxembourg (FCP), Ireland (CCF) and the Netherlands (FGR). Figure 7. Asset pooling a future-ready solution Asset pooling solutions can be used in IORPs and also for pooling non-european assets.

7 The Journal of Superannuation Management 7 Figure 8. Additional returns gained from tax-transparent investment vehicles In connection with this, it is very important that the asset pooling provider handles the tax rebate issues on behalf of its clients. This in itself can provide considerable benefits, as many investors simply do not apply for tax rebates as the procedures are particularly complicated. This was confirmed by the EU Internal Markets Directorate General in a memo in October stating that many investors do not reclaim their share of the 5.47bn in foregone withholding tax annually. Tax efficient pooling Claiming back taxes requires expertise In October 2009, the European Union s Internal Markets Directorate General issued a memo stating that many investors simply don t reclaim their share of the 5.47bn in foregone withholding tax annually. The procedures for validating investors entitlements are so complicated that they discourage investors from applying. For those who do apply for reimbursement of their taxes, the cost of doing so is thought to amount to approximately 1.09bn every year. The clear benefit of tax-transparent investment vehicles Tax-transparent investment vehicles offer a clear advantage to investors in comparison to tax-opaque vehicles (as illustrated in the graph below). Over an 8-year period, the return on investment from a portfolio where all dividends can be reinvested outperforms a portfolio where withholding tax is paid by about 6 per cent (for example, a Luxembourg-based SICAV Equity fund). For example, if we were to take a closed Defined Benefit pension plan of EUR 50mln in 2001 (into which no further contributions are being made), by October 2008, the total assets of he plan would be EUR 76 million if all dividends were reinvested as opposed to EUR 73 million if taxes were paid over the dividends. Over 8 years, this would amount to a loss of almost 3 million euro. If instead we look at a new Defined Contribution plan set up in 2001 for 150 members, with a contribution rate of 6 per cent on average salaries of EUR 30,000. After 8 years, if withholding tax were paid (and if 100 per cent of assets were allocated in equity), the total pension assets would be approximately EUR 2,480,000. If a tax-transparent vehicle were used the assets would instead be about EUR 2,540,000 a difference of approximately EUR 60,000 or more than 2 and a half months premium. Although these costs are more likely to be borne by the participants, the cumulative effect over the course of an individual s working and saving life would be significant and the worth of the benefit provided by the employer would be unnecessarily devalued. A first step towards pension pooling Multi-client asset pooling is a first step towards building a shared service centre for pensions for multinational companies. Given the changing pensions environment, it is very important that any asset pooling solution should be flexible and future-ready, as a company s needs are likely to change and develop. Although it will be a long time before cross-border IORPs are commonly in use, IORPs do already exist and their use will continue to grow. Asset pooling solutions need to be able to fit seamlessly into an IORP, if and when necessary. In addition, unlike IORPs, asset pooling solutions extend beyond the borders of Europe, enabling companies to manage their pensions through a single vehicle. For example, in an advisory opinion on pensions in , the US Department of Labor opened up the possibility for US pension assets (ERISA) to be pooled, along with pension funds from the Middle East, Asia, Africa and Europe. A modular solution should be able to service the different types of asset management models required by different pension systems. Although some companies will be able to reap benefits from more customised solutions, it is important to find a balance between increased costs and the benefits to be gained. A standardised, multi-client asset pooling solution can be easily and efficiently implemented. An asset pooling solution must: l Be efficient and transparent, with low operating costs l Have low implementation costs l Provide excellent governance and control over the investment solution l Provide a high quality investment solution that is suitable for a variety of pensions l Provide consolidated reporting

8 8 The Journal of Superannuation Management l Offer a modular investment solution to service different asset allocations and currencies l Be future-ready for IORPs, and the shift from DB to DC pension plans. Most importantly, an asset pooling solution must deliver value to all stakeholders, and not just the CFO. A good asset pooling solution should offer improved governance and control for the CFO, a solid investment solution fitting local requirements for the trustees and employees, and low costs and reliable high quality for the local subsidiaries. Asset pooling comes of age Now that the hype around asset pooling has died down, it is time for companies to reassess the available asset pooling solutions. Multi-client asset pooling provides companies with a flexible, future-ready solution that will help them to drive down costs and to improve their risk control and pensions management. Asset pooling is available and achievable now. Improving international pension management By enabling companies to harmonise the management of their pension plans, multi-client asset pooling provides them with increased control and consolidated reporting. Not only does this allow companies to better understand and control risk, but it also enables them to optimise the management of their portfolio of pension assets. Smaller pension funds can benefit from access to the best managers, and all pension funds can benefit from transparent costs and competitive management fees. Asset pooling reduces complexity for the corporate headquarters, provides high quality asset management solution for the local subsidiaries (coupled with reduced operational and reporting costs), and provides local trustees of the individual pension plans with good investment performance and increased diversification at a low cost. Five steps to implementing asset pooling For asset pooling, a step-by-step implementation process is preferable to a Big Bang approach. As asset pooling is introduced across a company, internal processes will have to be altered and adapted, and contacts and contracts with external providers will have to be changed accordingly. If pension plans are added one at a time, as they become ready to join, any issues can be dealt with as they arise. Step 1 Establish whether asset pooling (or other pooling solutions) will benefit your company. Does centralisation fit within your company culture? Step 2 Identify which pension plans you have, in which countries. Which assets do you hold and in what kinds of investment vehicles? What types of plans do you have, with how many participants? Step 3 Perform a cost benefits analysis establish the potential benefits of asset pooling in terms of cost savings, improved control, risk management and reduced tax drag. Identify which pension plans will benefit from asset pooling not only in terms of potential savings for the company headquarters but also in terms of quality of investment solutions available for members, trustees and local subsidiaries. Step 4 Secure executive sponsorship involve all stakeholders, from board members to local trustees in order to identify their requirements. Together with your consultant, identify the appropriate asset pooling solution for your needs. Carefully balance the need for your own unique requirements (and the added complexity this may bring) against the benefits offered by easy-to-implement, ready-made scalable solutions. Step 5 Plan and execute. Make a detailed project plan of how and when to switch from the current investment solution to the asset pooling solution, taking into account local requirements and long running contracts. l Notes 1 Planning your way out of the financial crisis, a roadmap to derisking, Jeroen J.J. Bogers, AEGON Global Pensions March IPE 31 March 2010: Multinationals unaware of overseas pensions cost, Allianz. 3 Statistics N 28, The role of insurance in the provision of pension revenue, September Note: CH: 3rd pillar underestimated; DE: Data for 2nd pillar missing; DK: 1st pillar is underestimated because it does not include contributions to the public scheme; FR, UK, DE, ES: 1st pillar estimated on the base of the benefits paid; IT: 2003 data; FR, UK: No split available between the 2nd and the 3rd pillars. 4 Source: Defined contribution pension schemes, risks and advantages for occupational retirement provision, Ofama Oxera January Christina Matos, Unreformed or Hybrid? Accounting for Pension Arrangements Diversity in the EU, Springer, 7 April Press announcement IP/09/1543, Brussels, 19 October 2009, Securities income: Commission recommends simplified procedures for claiming cross-border withholding tax relief A ERISA SEC 404(b) U.S. Department of Labor advisory opinion concerning the indicia of ownership requirements in section 404(b) of the Employee Retirement Income Security Act of 1974 (ERISA), and the implementing regulations.

9 The Journal of Superannuation Management Published by a Rainmaker Information company Level 2, 151 Clarence Street, Sydney NSW 2000 Australia Telephone (02) Facsimile (02) Disclaimer The Journal of Superannuation Management ISSN Copyright 2010 Rainmaker Information Pty. Ltd. ABN All rights reserved. This work is copyright. Apart from any use as permitted under the Copyright Act 1968 of the Commonwealth of Australia, no part of this journal may be resold, reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the publisher. Rainmaker Information Pty. Ltd. gives no warranty other than any warranty that may be implied pursuant to the Trade Practices Act 1974 that the information in this report is correct or complete. Rainmaker Information Pty. Ltd. shall not be liable for any loss or damage howsoever caused due to negligence arising from the use of this report. The views and opinions expressed in this journal are provided for information purposes only and should not be taken as constituting advice. Persons concerned with the issues raised in this journal should seek their own professional advice. No responsibility is accepted by the publishers, its employees, agents or associates for the accuracy of the information contained in this journal. The opinions expressed in this journal do not necessarily represent the views of the publisher.