INFLATION RELATED PENSION PAYMENTS
WHY THE CHANGE?
A. INTRODUCTION
As Shell pensioners, we receive many letters from Shell asking for help and support. Pensioners are willing supporters and proud of their Shell service. We are writing to you, a senior leader of Shell Oil, for the same reason. We ask for your help and support.
You may or may not be aware that in 2007 Shell significantly changed and reduced Inflation Related Payments (IRPs) for pensioners. IRP is a program of periodic pension increases to offset the effects of inflation on pensioners’ purchasing power. Shell Oil Company has made IRPs to pensioners since the late 1940’s. Until 2007, pensioners had been able to rely steadfastly on the goodwill and sound judgment of Shell Oil leaders to determine and authorize fair IRPs. Now, most recently, IRPs have been greatly changed and reduced without explanation.
B. PURPOSE
Overall, the purposes of this paper are to provide information and request your assistance. The paper will summarize the:
· History of Inflation Related Payments;
· Competitive Landscape;
· Changes Made to Inflation Related Payments in 2007;
· How Changes to Inflation Related Payments Affected Pensioners; and
· Potential Implications and Consequences of Inflation Related Payment losses.
Our request is that you:
· Read this paper carefully, learn about IRPs, and check the facts;
· Consider the potential business implications and consequences of IRP changes and the resulting losses Shell people have suffered.
· Ask yourself if the new, unexplained, reduced approach for IRPs adopted in 2007 is a sound business decision;
· Help to redress the 2007 IRPs handling.
C. HISTORY OF INFLATION RELATED PAYMENTS
Shell Oil Company adopted its Pension Plan in 1938. In the 1940’s, Shell pensioners received their first supplemental checks from the Company. These pension supplements helped offset the erosion in purchasing power caused by inflation. Thus, began the first of many supplements to Shell pensioners. Shell Oil had established a great tradition of Inflation Related Payments for pensioners. IRPs were granted over and over again although the provisions of the Shell Pension Plan and numerous collective bargaining agreements did not formally obligate Shell to make them. It is true that pensioners were told IRPs were not an entitlement. Nonetheless, pensioners have a longstanding expectation of fairness because Shell has granted them for almost sixty years.
For many years, the Company made these periodic inflation adjustments willingly and fairly based upon the responsible judgment of Shell leadership. The most recent IRP was effective in 2007. Unfortunately, it went astray. We explain why we feel this way in what follows.
The amount and timing of IRPs varied for the first few decades. In about 1980, Shell Oil Company began making IRPs when inflation had increased by about 20% measured from the date of retirement. The amount of the payment was approximately 50% of inflation. As each retirement year class qualified for IRPs, pensioners who retired in prior years saw their pensions adjusted too. On an ongoing basis, the program provided protection for approximately 50% of inflation for all pensioners. The exact timing and amounts of the IRPs varied , but it is fair to say that the Company attempted to offset 50% of inflation and did so once inflation had gone up about 20% from the last IRP adjustment. This sound policy approach continued for nearly three decades and guided Shell management in administering the program. This practice became widely known and pensioners often asked Shell leaders about IRPs at regular meetings. Employees and collective bargaining agents also knew of the program, but only generally.
In 2007, Shell dramatically changed this practice and greatly reduced the amount of IRPs. This was done without any explanation to active employees, those preparing to retire, or to pensioners. Various Company representatives have been asked why IRPs for pensioners were substantially changed and reduced. There were also questions asked about what employees, as well as pensioners, might reasonably expect regarding future IRPs. These inquiries have not been satisfactorily answered.
Consequently, Shell Oil pensioners and employees can only guess and speculate as to why IRP reductions were made in the United States but not in the United Kingdom nor in the Netherlands. In these latter two countries, we understand that pensions are adjusted annually for 100% of inflation and have been for years.
One possible explanation for the IRP reduction is that Shell Oil Company’s shareholder may be concerned that a formal obligation to fund IRPs for the future might arise, thereby accelerating by years the demand on Company cash and effect on book revenue. For many, many years, the Company paid IRPs with separate checks drawn from general revenue and not from a pension trust. This expense was booked only in the year of IRP approval and required no pre-funding. We expect that the approach of incurring expense only in the year a new IRP program is approved continues to be of paramount importance.
Shell eventually did find a way to use a portion of the surplus funding of the Pension Trust (created mostly by stock market gains) to fund a portion of IRPs. While this new funding approach applied to IRPs of earlier years, it made no promise of future IRP increases. Now, Shell pension checks had IRPs added to pension checks, and such approved payments were from the “official” Shell Pension Trust Fund. The enabling Shell pension plan amendments were carefully crafted so as not to create a formal obligation for future IRPs, that decision being left to future ad hoc Company decisions. As to accounting, in the past, Shell Oil did not financially book future IRPs since they technically were not a formal on-going obligation. Nonetheless, IRPs are a longstanding policy and practice.
Booking and pre-funding issues, however, are not a new concern. In the mid-1990’s, steps were taken to evaluate carefully the legal and financial risks of IRPs becoming a formal obligation. Shell hired respected third party pension, accounting and actuarial experts to evaluate this funding risk. Among other things, these experts presented Shell’s fact case (without using Shell’s name) to relevant government agencies and to the Financial Accounting Standards Board. All these experts concluded that the approach Shell had been using for IRPs presented only a very small risk that Shell would be required to book or pre-fund future IRPs. The overarching point is that until 2007, Shell Oil leadership has been very capable of both prudent financial management and treating pensioners fairly.
It is important to point out that over time the overall cost of IRPs made by Shell will become smaller and smaller until they are de minimis. This will occur because of the pension change made in 1998. At that time, Shell gave employees the annual choice of continuing in its current defined benefit pension formula plan (historically supported by IRPs), or enrolling in a new cash-out formula plan.. In this new optional pension formula plan, electing employees receive dollar value credits (from Company contributions and pre-set investment yield) to their own personal retirement account. At the end of their careers, they have money that they can withdraw in a lump sum or in increments. This eliminates the need for IRPs since the pensioner can now offset inflation through his or her own investing. Nearly 90% of new hires enroll in this optional cash-out pension formula plan. Pensioners with fixed pensions from the defined benefit formula do not have this investment flexibility and thus rely on IRPs to offset part of inflation’s voracious appetite.
D. COMPETITIVE LANDSCAPE
We hope that Shell Oil leadership continues to believe that its compensation and benefits must be strongly competitive to attract and retain the best and brightest talent. Historically, Shell regularly conducted competitive comparisons to ensure that Shell was not at a disadvantage and was meeting its competitive goals. Shortly after the U.S. Oil Industry broadly implemented pension plans, almost all of Shell’s competitors gave their employees the option of taking a lump sum payment or receiving a lifetime monthly pension. The purpose of the lump sum option was to allow the pensioner to invest the lump sum payment and thereby offset the effect of inflation. The majority of our competitors still allow employees to take a lump sum option rather than only a lifetime monthly pension.
Shell Oil, however, took a different approach. In the 1940’s the general level of financial and investment acumen in the United States population was low. In addition, the transparency of financial markets was much less than today. Shell was concerned that many pensioners might make poor investment decisions and end up destitute after long, loyal Shell careers. Therefore, Shell decided not to allow lump sum payments from the pension plan. Instead, Shell decided to help offset inflation by making Inflation Related Payments to pensioners with fixed monthly pensions. Today, one might argue against this paternalistic approach, but for the times it was a reasonable decision.
Over the years, it became very clear that not allowing a lump sum payment, as our competitors did, was extremely beneficial to Shell. By not allowing lump sum payments for pensioners, Shell retained this money for investment in the Pension Trust and thereby reduced annual pension contributions required of Shell’s businesses. Benefiting from the last sixty years of investment earnings and growth, Shell Oil Company has saved billions of dollars that would have been otherwise paid out in lump sum payments to pensioners. In this respect, we have been the envy of our competitors.
In the mid-1970’s, regulatory and statutory changes were made that limited tax advantaged pension trust fund payments to a fixed dollar amount. At that time and in response to this regulatory change, Shell set up a Benefit Restoration Plan (BRP) to pay restricted new pensioners a make-up from the Company’s general revenue. This payment covered the pension amount they had earned as employees above the low regulatory dollar cap.
Additionally, during the mid-1970’s, the U.S. Congress introduced a pension insurance program, creating the Pension Benefit Guaranty Corporation (PBGC). This program shields individual pensions, up to a limited amount, from default by pension trust funds. Over the years, this insured amount has varied and currently is set at $2,630/ month for a 2008 retirement at age 59. The cap is noteworthy because many pensioners have only part of their pension insured by the Pension Benefit Guaranty Corporation. Furthermore, payments from the BRP depended on the Company generating sufficient revenue and are not eligible for the PBGC insurance.
In the 1990s, Shell Oil changed its BRP to allow new retiring employees to elect lump sum cash-out payments, but only for the part of the overall pension paid from the BRP. These changes were made because BRP pensions are not insured by the PBGC and are subject to the Company’s general revenue being adequate. However, employees who retired before this change were not included, and their only option is to continue to receive monthly pension payment from the Shell Pension Trust and the BRP if applicable.
The large majority of our major competitors (if not all of them) allow their retiring employees to elect to take their entire pension as a lump sum, whether payable from a tax favored qualified pension plan or from a BRP. Since competitors’ pensioners can invest, they can protect themselves from inflation. At Shell, this personal investment opportunity is limited to payments from the BRP that were initiated after the amendment in the 1990s. Accordingly, Shell pensioners need and require strong and fair IRPs for both inflation protection and to meet Shell’s competitive objective.
It is clear that Shell has a strong financial incentive not to allow lump sum payments because the investment income earned by the Shell Pension Trust greatly reduces Shell’s funding obligations. However, this policy places Shell Oil’s retiring employees at a disadvantage since they cannot take their entire pension as a lump sum and invest it to protect against inflation. Historically, Shell helped offset some of this disadvantage by making reasonable IRPs. We are concerned that Shell Oil has abandoned its decades- long, clear, and reasonable approach of IRPs for pensioners in the United States, as evidenced by the dramatically changed and substantially reduced 2007 IRP program. Finally, we understand that pensioners in the United Kingdom and the Netherlands have their pensions adjusted annually for 100% inflation. We wonder why American pensioners are now being treated so poorly.
The IRP process has worked well up to now because the needs of both Shell Oil and pensioners were met. Shell Oil had clear financial advantage and pensioners got fair IRPs. So, there was no need for Shell people or union leadership to seek a more formalized obligation as both benefited.
E. CHANGES MADE TO INFLATION RELATED PAYMENTS IN 2007
For nearly three decades, Shell made Inflation Related Payments when inflation increased by about 20%. The amount of the payment was a roughly half of inflation (approximately 10%). We have been able to pull together what we believe is a reasonably accurate representation of the changes made to IRPs in 2007 as compared to the historical method. The 2007 Payment column in the table is not totally accurate for all pensions due to the maxima Shell imposed. The percent increase for pensions above $3000/mo for the years 1995-98 would be considerably less than the 10% shown in the tables.