Multinationals moving - slowly - to integrate disparate pension plans

The financial crisis eventually will push more multinational pension plan sponsors to better centralize their corporate pension activities, but in the short term, the route might be marred by more pressing concerns such as a growing deficit, poor returns and volatile market conditions.

“What the months of (financial) carnage did was to show that many multinational companies don’t have the infrastructure in place to know exactly what the carnage was doing to them from a pension risk management perspective,” said David Fogarty, principal in financial strategy group of Mercer Inc. based in London. “That is bound to change.”

Consultants and fund officials expect a more centralized pension management system in which investment risks are better understood and controlled from a companywide perspective.

Before the credit crunch, which began to emerge in the summer of 2007 and gained steam in 2008, corporate sponsors already were looking at their pension plans throughout the world from a risk perspective, said Christopher Mayo, senior consultant at Watson Wyatt Worldwide based in London. But many sponsors had been slow to act. Then “the crisis came along and demonstrated what could occur” when companies haven’t taken steps to better control pension investment risks, Mr. Mayo said.

“There has been a significant impact on assets and liabilities,” he added. “The risk that pension schemes have has been brought home.”

In 2008, global institutional pension fund assets lost an average 19% of total assets, according to data for 11 major markets compiled by Watson Wyatt Worldwide, Reigate, England. Separately, the funding level at the largest 100 U.S. corporate pension plans shrank by nearly 30 percentage points in 2008, giving up gains from the previous five years (Pensions & Investments, June 1).

Across Europe, corporations with multiple plans have been trying to squeeze more efficiency from the way they manage their defined benefit pension assets for years. The “single currency, single economy” of the European Union was supposed to have translated into the pensions industry through the Directive on the Activities and Supervision of Institutions for Occupational Retirement Provision.

While progress is slow, more companies are investing pension assets in cross-border funds. For example, there were 70 companies with cross-border pension capability in the European Economic Area as of June 2008, a 40% increase — or 22 cases — from the previous 18 months, according to a survey conducted by the Committee of European Insurance and Occupational Pensions Supervisors.

“There has been an uplift in the aggregate number of cases, which is significant in percentage terms, although small in comparison to the scale of provision of occupational schemes across the EEA generally,” according to a report that accompanied the survey. CEIOPS, based in Frankfurt, advises the European Commission on regulatory matters affecting the insurance and occupational pension industries.

However, advances in cross-border plans have been on a piecemeal basis. Most pension vehicles link only a few countries rather than being a fully integrated multinational fund, according to data from CEIOPS.

But the efforts have paid off for those companies that have invested in integrating their worldwide pension assets and liabilities, particularly during the liquidity crisis. Nestle SA, Vevey, Switzerland, is among them.

“The fact is that because we have a much better handle on all the major pension plans, it has helped us to keep management — including the board of Nestle — informed on a monthly basis as the crisis unfolded,” said Jean-Pierre Steiner, chief executive officer of Nestle Capital Advisers, the company’s internal pension adviser with about 25 billion Swiss francs ($23.35 billion) in assets under advisory.

The structure in place to monitor pension risks globally “also allowed us to follow (funding levels) very closely and to react rather quickly,” said Mr. Steiner. For example, asset protection measures such as the use of options or reducing the allocation to equity portfolios helped to minimize losses as markets tumbled globally in 2008.

In 2008, which is the second full year in which Nestle Capital had been in operation, the majority of the pension funds under its watch have outperformed their respective benchmarks, Mr. Steiner said. “We have added value,” he added. (Nestle declined to release specific performance data on individual pension plans.)

Nestle SA has about 280 pension plans worldwide, but the largest 20 hold between 85% and 90% of total assets. While the company is one of the pioneers of cross-border pension asset pooling, Nestle does not yet offer a true pan-European plan.

Hurdles are still difficult to overcome for multinational companies, not least of which is the political power wielded by local trustees. Differences in government regulatory requirements between nations and the cost of setting up the infrastructure that would allow for pension pooling are other major roadblocks, experts said.

“Most companies are already struggling to afford the cost of a (defined benefit) pension scheme,” said Paul Kelly, senior consultant within Towers Perrin’s Global Consulting Group based in London.

One of the toughest barriers to cross-border pension plans — taxation — is being slowly chipped away. European tax experts say it is only a matter of time before investors will see tax refunds — and likely tax-free investing in the future — from changes expected in European Union member states’ tax laws.

Total refunds from EU governments could be in the billions of euros, while investors could see an ongoing annual tax savings of about 15% on investment proceeds if countries amend laws accused of being discriminatory.

“It potentially could be a very big savings,” said Kit Dickson, senior manager, large corporate and international tax, in KPMG LLP’s EU law group in Manchester, England. Mr. Dickson is leading KPMG's efforts to reclaim for U.K. pension fund clients withheld taxes from EU governments.

At issue is European governments’ collection of taxes on investment proceeds from foreign investors that are tax-exempt in their home countries. If a country waives taxes for domestic pension fund investments, it must allow foreign pension funds’ investments to be tax-free, too, experts say.

And the winds of change seem to be blowing in their direction. Pension fund plaintiffs have won cases in recent months in the Netherlands and France that experts say will clear the way for wider tax reform, while the European Commission has sued 14 EU member states for such discriminatory tax laws. The EC has referred Spain and Portugal to the European Court of Justice, the EU’s supreme court.

“If the ECJ rules in favor of the pension funds, it is unlikely that the commission will have to take the other 12 member states to the ECJ as well,” said Peter Schonewille, an EC principal administrator, wrote in a published opinion in February.

Mr. Schonewille said tax-free status should be given not just to pension funds from fellow EU countries but to all tax-exempt investors, as “Article 56 of the EC Treaty also prohibits all restrictions on the movement of capital between member states and third countries,” and that real estate investments should also be tax-free.

Another development that is set to lower tax bills for pension funds and other institutional investors is the tax-transparent pooled fund. The structure allows investors — for example international equity managers investing on behalf of pension funds — to pool assets without losing the pension’s tax-favored status.

Aaron Overy, vice president, business development for pooling at Northern Trust in London, said withholding taxes can cause 90 basis points of drag for an investment. “If you remove that, you’re happy,” he said.

The shift to defined contribution plans from defined benefit might help to accelerate cross-border pension activities because there aren’t as many regulatory and structural constraints in DC as there are in DB, Mr. Kelly of Towers Perrin said. For example, the firm recently advised one multinational company to establish a pension plan to cover employees across the U.K., Ireland and Poland.

“It was more cost-effective than setting up individual schemes,” he said. “You don’t have the same constraints in DC compared to DB.”

Consolidating plans through cross-border transfers of pension assets and liabilities has become more prevalent in the past year. In one case, a multinational firm in the eurozone moved pension assets of less than e100 million ($142 million) to another country within the same economic zone altogether, Mr. Kelly said.

“Deferred pensioners and pensioners remained, effectively putting the (multinational company) in a position to eventually close that down,” Mr. Kelly said. “The main driver is that corporations want to get out of DB, and a cross-border pension plan provides them with a tool to do that.”