Ray Martin talks to Fennell Betson

When UK bio-tech group Zeneca revamped its pension scheme after the demerger from chemicals giant ICI, it engaged in a little genetic engineering. The result is a very successful hybrid - the Zeneca Lifeplanner.

One of the plan's key experimental features is to express the defined benefit in terms of a defined contribution approach. Group pensions director Ray Martin says: We wanted to communicate the benefit not as pension but as a cash sum. This was quite novel and the shame is that everyone thinks we have gone DC." In fact, it has done both.

After the demerger in 1994, the new group's scheme was providing top-level benefits but in a highly complex package. Indeed, the benefits were perhaps over the top compared with those of competitor employers fishing the same pond for future staff.

An extensive attitude survey responded to by 2,500 of the 12,500 employees, revealed that while they appreciated the level of benefits, they wanted something simpler to understand. In addition to greater choice over contribution rates, they felt the benefits should be of equal value to those who stayed with the company and to those who left even after a short period.

"What we attempted to do was to integrate the two approaches, but without trying to cut the cost of the scheme," says Martin. Under the resulting Lifeplanner scheme introduced in mid-1996, new employees aged under 45 join the DC portion called the investment account, with the choice of a 2% of pay contribution rate (when Zeneca contributes 6%) or 4% (Zeneca 8%) into an index fund. In fact, nearly 60% contribute at the higher rate, including the younger ones. The cash value at retirement is used to purchase an annuity from the fund.

The DB element, designat-ed as the retirement account, is similarly expressed as a cash sum at the age of retirement, but its size will depend on the length of service, the set annuity rate used by the actuary, and what dependent benefits are included, which will affect the annuity rate. For example, the employee builds up a cash sum at the rate of 24% of final salary on the standard one-sixtieth basis, where the annuity rate is £14.40 per mille at retirement age (1/60 ¥ 14.4 = 24%). As Martin says the rate of interest on this account can be regarded as the rate of growth of the employee's pensionable pay.

The DB scheme contribution rate is a minimum of 4%, but with options to pay higher contribution rates and thus build up the cash retirement sum more quickly.

At age 45, those in the DC investment account are given a once and for all opportunity to switch to the DB retirement account. They will get 24% or 16% of final pay for each year they contributed 4% or 2% respectively.If the employee continues in the investment account, the company in-creases its annual contribution to 8% or 12% where the employee is paying 2% and 4% respectively. On both accounts, no further contributions are payable, where the amount becomes 950% of pensionable pay, because this is the sum that will obtain the maximum pension allowed of two thirds of final pay, at the annuity rates being used currently.

The Zeneca fund provides its own annuities. "Generally, the UK annuity market is expensive, being competitive at an uncompetitive level," quips Martin. "Our approach is to be cost neutral and we are always much better than the best annuity rate in the market." The fund takes the indexed annuity gilt yields and calculates in line with those. "There is a bit of reinvestment risk as people tend to live longer than the duration of the longest bonds you can buy. The risk is quite small and the insurance companies charge a huge premium for this!" The fund can vary the annuity rates on offer at retirement to employees joining after 1996, including those on a DB basis, which gives it an additional degree of flexibility to cope with changing mortality patterns.

The fund, which has assets of £2bn ($3.2bn), runs DC assets as part of the main fund. "We annuitise the benchmark of the fund in line with with the indices of the underlying investments, but we will move this towards an indexed fund," he explains." If we were to do this now, we would end up paying more than we do for active management as the fund is so small." The benchmarks currently are roughly a 70/30 equity/bond ratio. Ultimately, a range of risk-profiled DC funds is to be added to this current "growth fund", with a "stable 50/50 fund" and a "growth plus" fund with 100% equities. "All will be passively run, with a life-style option to phase into cash."

From a corporate viewpoint having part of the fund on a DC basis will hopefully reduce the cost volatility. Martin says under 40% of new employees stay to age 45, so the company knows pretty well where it stands. Also, as the minimum funding requirement (MFR) does not apply to the DC portion, this reduces the likelihood of the company having to make top-ups to the fund. However, the company, which has been contributing at 17.5% of payroll to the scheme since early 1996, was hit by the government's move last year to tax equity dividends that increased the funding level to 20.6%.

Currently, the fund is 100% actively managed, with five external specialist managers: Mercury, Schroder, PDFM, JP Morgan and First Quadrant. "We are having the bond element passively managed," says Martin. About 30% of the fund is in bonds and around £300m will be transferred to Legal & General across a range of funds. "The main reason for the switch is lack of performance in the bond area." With the increasing maturity of the fund and MFR, the trend to bonds will increase all the time, he reckons.

First Quadrant was introduced last year as a tactical asset allocator. "This was MFR-related, as we have 70% in equities as our long-term strategy but our MFR match was a 50/50 split, so we appointed First Quadrant to take us out of equities when markets are overvalued and to move to 50%."

But First Quadrant's activities are also directed towards protecting Zeneca corporately from adverse moves which could result in having to pump additional funds into the pension fund and has set up a protection portfolio for the sponsor through an options programme to offset equity market falls.

Martin is also head of Zeneca's pensions arrangements globally, which cover 50 plans around the world, with another £1bn of assets, of which £600m is in the US schemes. "It is the smaller schemes that take up most of my time, as they often do not have their own staff," he says. "We are looking to consolidate our plans to a common philosophy and we are moving very much to DC globally." A number of the European schemes have already moved to DC. "Portugal has done so, as has France and Germany, while Italy is having it by law and Spain is in the course of doing so."

He adds: "The next step is how we co-ordinate pensions around Europe." He believes that the moves to DC increases the options available. "It is possible to go quite far down the integration route if the mind-set is DC."

Martin is convinced of the need for a Euro-style plan. As a vice-president of the European Federation for Retirement Provision, he says he has been lobbying for a European solution. "Why can't a pension fund in one country have sections tax qualified in it for other countries. So why not have a UK pension fund that is Dutch or Belgian tax-qualified as well? You could have all your employees in one fund, with separate sections. This is happening in life insurance as life companies established can operate in any other EU country, provided it meets the tax requirement of that country.

While he does not see real EC progress on the pensions funds until the euro is up and running, he is hopeful the mobility directive will go through. Zeneca has defined its policy to its own mobile employees. Most employees move around on short-term assignments and stay in their home country plan. Those on up to three-year assignments are on secondment and stay in their own home scheme, even when on expatriates' pay.

For those who are permanently transferred, they remain employed by the group, their home country has to increase their deferred DB pension in line with inflation plus another two percentage points. "And, of course, for DC there is no issue." Another sign of the times."

Topics