Financial Times: Shell reverts to a vanished norm

By Norma Cohen
Published: October 9 2007 03:00 | Last updated: October 9 2007 03:00

When Shell UK, part of the Royal Dutch Shell oil group, said its pension scheme was so well-funded no contribution would be needed this year, it sent a frisson of excitement through the City.

The comeback of the contributions holiday – once the norm in large UK schemes – is of interest to corporations for whom the pension scheme has been little more than a large black hole.

Pensions experts are, however, quick to warn against a return to the days when companies reckoned they could make generous retirement promises at little cost to themselves. They say Shell UK is likely to be an isolated – perhaps even unique – case.

Indeed, the good fortune of the Shell scheme appears still more surprising after two recent surveys, the first by the Pensions Policy Institute questioning the future of defined benefit schemes. The second, by the CBI, found employers have contributed heavily to schemes at the expense of profits.

Contributions holidays for years allowed companies to offer retirement benefits at no cost to shareholders.

The concept of what makes a contribution holiday possible – the presence of a surplus – is highly changeable, depending upon several factors.

Foremost among these are equity prices and interest rates, along with the subjective choices an actuary may make to measure liabilities.

Indeed, actuaries concede privately that before the formation of the pensions regulator in 2004, they were free to make a wide range of assumptions, many tailored to an employer’s desire to limit contributions.

“The propensity for contributions holidays to exist under the present (regulatory) regime is much less,” says Stephen Yeo, a partner at Watson Wyatt, actuarial consultants. Before that, “employers had the whip hand,” he says.

The Pensions Act of 2004, which formed the regulator, gives more power to trustees.

“I think we need to be careful what we are talking about when we talk about surpluses,” says Aaron Punwani, a partner at Lane Clark & Peacock, another actuarial consultant.

The excitement about Shell UK’s contributions holiday has been been fuelled partly by a series of good news items about deficits. Several consulting firms have produced recent analyses showing many FTSE 100 companies’ pension schemes in surplus.

These, in turn, have been fuelled by an unusual combination of market conditions: rising equity values coupled with higher interest rates.

A bias towards equities in UK schemes has swelled their coffers while the discount rate used to measure future liabilities is also rising.

A rise of 1 percentage point in interest rates at current levels cuts scheme liabilities by about 25 per cent.

But Mr Punwani urges caution. The method used to calculate pension liabilities for accounting purposes usually produces numbers far below those needed to guarantee all promised benefits could be paid out if a scheme were to be wound up immediately. That number, known as a buy-out deficit, is typically as much as a third higher than the one shown in corporate accounts.

“I think some of the excitement [about] pension surpluses is a little bizarre,” says Charles Cowling, managing director at Pension Strategies, the pensions risk advisory firm. For accounting purposes, companies use the rate prevailing on AA corporate bond yields.

As those have risen in the credit squeeze, so too have accounting deficits appeared to shrink. That shrinkage, Mr Cowling says, does not represent any real decrease in liabilities.

The Shell UK pension scheme is understood to be at – or very close to – full buy-out funding.

The trustees have agreed tothe holiday and the scheme was so well funded it did not, unlike the majority of schemes, need to submit a recovery plan to the regulator.

For his part, David Norgrove, the regulator, has stated his dislike of contributions holidays, and any scheme that plans one risks triggering a funding review. The regulator prefers level, ongoing contributions to cope with any future hikes in payments.

In respect of Shell, the regulator says: “Where there is a very high level of funding it may be appropriate to take a contribution holiday and this should be regularly monitored.

However, in those schemes where there is a deficit, we would not view this as appropriate.”

Separately, pensions advisors say Shell UK is not alone in being unusually well-funded. What is rare, however, is that Shell’s scheme remains open to new employees.

For schemes with few or no active members, winding up the scheme and selling assets and liabilities to a pension provider may be a better solution.

Indeed, providers such as Paternoster and insurers, such as Legal & General, report a surge in schemes seeking bids.

Mr Punwani says this approach can help companies avoid risks far removed from their core business. They would also have more flexibility if they did not need to discuss transactions with trustees.

Copyright The Financial Times Limited 2007

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