Not many companies are closing defined contribution schemes. Laura MacPhee meets one scheme going in a different direction

Closing a defined benefit scheme may be standard procedure these days, but not many companies have shut down their defined contribution schemes. AstraZeneca took this unusual step a little over two years ago.

The pharmaceutical giant gave its employees the choice to stay in the DB fund at a frozen level of salary, which remained open to new entrants, or to switch to its group self-invested personal pension scheme (GSIPP).

Astrazeneca

The company took this decision in 2010. So what was the reason for all this upheaval? The answer is not surprising. “Cost,” says trustee Eike Floetmann.

The administrative costs of launching a GSIPP were lower than running a DC scheme

The administrative costs of launching a GSIPP were lower than running a DC scheme as Legal & General run the GSIPP independently of the trust. The picture looked less than rosy in the late Noughties when AstraZeneca was looking at the future of its DC arrangements. Its ultimate decision was a controversial one.

The GMB union opposed the decision to move to freeze the DB scheme, and organised industrial action. There were walkouts during the September of 2010, but Floetmann remembers less upheaval than he expected. The pharmaceutical industry traditionally offers a generous pension as a recruitment and retention tool, and AstraZeneca is no exception.

Floetmann says the employer contributes “between 12 and 16% into the GSIPP”. This compares to the 24% of salary for workers still signed up to the AstraZeneca DB arrangement, albeit that this proportion has been frozen at the 2010 levels of salary. The GSIPP offers members a wide variety of investment options. These strategies are generally “passive in the more mature markets, active in the less mature market options”, explains Floetmann.

All the trustees work for the company, with the exception of one independent trustee

The trustees worked closely with the employer to distribute information about closing the DC scheme and introducing the GSIPP, but ultimately “it was a company decision and therefore company communications”, says Floetmann. From a trustee perspective, there was a ‘shift in thinking and communication”, when AstraZeneca made the changes to its pension arrangements.

They discussed what they would need to do in the future, and how they needed to position the trust outside the company. All the trustees work for the company, with the exception of one independent trustee. Floetmann says they are “very good at identifying conflicts and working around them”.

NEARING THE CLIFF

The need to make savings had become particularly urgent for AstraZeneca because of a problem known as the ‘patent cliff’. Many of the drugs that the pharmaceutical giant depends on for income are reaching the end of their patents. This will mean a sudden drop-off in sales, hitting the company’s balance sheets hard, and weakening the employer’s ability to support the scheme.

The company managed to push back the cliff this year by arranging a £294m deal to buy US company Omthera, which is developing a drug which helps prevent heart attacks by lowering the levels of fat in the blood. Pascal Soriot, AstraZeneca’s chief executive argues that demand for the product should remain high due to rapidly rising levels of obesity and diabetes.

The company also just announced its intention to acquire Pearl Therapeutics, which produces treatments for respiratory disease, so it seems to be safe for now. As a strong employer is the best asset a scheme can have, so the trustees were eager to find ways of easing the financial strain on the company.

MAKING YOUR MIND UP

But the decision-making process was a difficult one for most members, since the outcomes differed from individual to individual. They were all given independent financial advice to help guide them through the process. For some employees there were other benefi ts associated with remaining in the frozen DB scheme.

Those who had been in the Zeneca scheme before it merged in 1998 would receive extra funding to buy additional years’ service, so it made sense for them to stay. As Floetmann points out, many of those who remained in DB were those who were closer to retirement, so had fewer years left to accrue and lower inflation risk. He says the few people who stayed in the frozen salary DB scheme only constitute “a tiny fraction of the membership”.

Floetmann confesses to concern over the uncertainty surrounding annuity rates

Floetmann knows about one employee who has hedged his bets by transferring to the GSIPP, while his wife – who also works with the company – stuck with the frozen DB scheme. As well as fitting their individual needs, this will allow them to see which course really gives the best member outcomes. Although satisfied with his own decision to opt for the new arrangement, Floetmann confesses to concern over the uncertainty surrounding annuity rates.

Despite the financial difficulties it has experienced, AstraZeneca has maintained its commitment to its frozen DB pension fund. Of all the FTSE 100 companies, AstraZeneca made it into the top 15 which made the largest contributions to their pension schemes, according to JLT’s February 2013 FTSE 100 report. The firm contributed £458m in the last year, putting it in 14th place. This seems a little surprising, given the company’s use of contingent assets, which are normally used when the employer wants to fulfil its obligations to the scheme without devoting too much cash to the cause. The company has created an escrow account, which is held outside the pension scheme.

AN ESCROW ARRANGEMENT

The advantage to the scheme of an escrow arrangement is that “the money’s actually sitting in the account, and the trustee can get hold of it in the circumstances that it would need to, for instance an insolvency,” says Sackers’ associate director Vicky Carr. The fund’s 2012 annual report states: “The escrow account assets are payable to the fund in agreed circumstances, for example, in the event of AstraZeneca and the pension fund trustee agreeing on a change to the current long-term investment strategy.” The trustees have also hired external advisers to assess the employer’s convenant.

The money’s actually sitting in the account, and the trustee can get hold of it in the circumstances that it would need to, for instance an insolvency

The 2012 annual report confirms AstraZeneca’s commitment to fund the DB scheme by way of lump sum payments totalling £715m. The fi rst of these payments, which equalled £180m, had been paid from the escrow account in December 2011, and was quickly followed by a £300m instalment in January 2012.

It also sets out the assumptions that the group is using for its UK scheme – long-term UK price inflation at 3.8% per annum, investment returns at 5.9% per annum, pension increases at 3.55% per annum, and salary increases at 0% per annum, reflecting the pay freeze within the fund. AstraZeneca treats its DB scheme “more like a closed scheme”, moving towards an endgame. “From a trustee point of view you want to take out the risk,” says Floetmann.

According to the most recent pension fund annual report available, at the end of 2011, the scheme had £5,329m assets under management, and liabilities of £7,038m. This gave it a funding level of 76%. The scheme was invested 39% in equities, 52% in bonds, and 9% in other assets, reflecting its aspiration to de-risk (see fact file).

How successful these approaches will be remains to be seen – as Floetmann says, “you only find out when you retire – that’s the problem”– but, in the meantime, restricting the schemes’ liabilities should come as a relief to the squeezed employer.