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
-1-
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
-2-
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 mid1990’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.
-3-
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.
-4-
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.
Here is the data table:
Year Retired
2007 Payment**
Historical Method**
1979 or Earlier
1980-1994
1995
1996
1997
1998
$100/mo maximum
6%*
10%*
10%*
10%*
10%*
6%
6%
16%
14%
13%
12%
*Each of these percentage adjustments was subject to $300/month maximum. With the historical method,
no maximum was ever imposed.
** The percentages are of the current pension. A 1995 retiree has experienced about 32% inflation. Under
the Historical approach, one-half or 16% would be covered by IRP’s. The 2007 method covers only 10%
with a maximum while treating the 1995-98 pensioners exactly the same.
For most pensioners the IRP component of their pension is a very significant
amount, and for some, it is much greater than their actual pension. For example, the IRP
for someone who retired in 1960 is 143% of their original pension, 97% for a 1970
pensioner, 43% for a 1980 pensioner, and 21% for 1990. Accordingly, it is apparent why
pensioners are so disappointed that Shell abandoned its historical practice. No doubt, you
have worked with hundreds of dedicated Shell people who have been negatively
impacted by the 2007 IRP changes.
E. HOW CHANGES TO IRPs AFFECTED PENSIONERS
The following table shows the annual loss in Inflation Related Payments made
beginning in 2007. To calculate this loss, we compared the 2007 IRPs to what the IRPs
would have been under the historical method.
-5-
Year Retired
1979
or before
1980-94
1995
1996
1997
1998
Annual Pension in Dollars Per Year
12000
24000
36000
48000
60000
72000
84000
Annual Loss of Inflation Related Payment–2007 Actual vs Historical#
(480)
0
720
480
360
240
240
0
1440
960
720
480
960
0
2160
1440
1080
720
1680
0
4080
3120
2640
2160
2400
0
6000
4800
4200
3600
3120
720
7920
6480
5760
5040
3840
1440
9840
8160
7320
6480
# Numbers below this header are negative representing lost IRPs amounts except for the 1979 retiree with
a pension of 12000/yr who received $480 more per annum with the 2007 method..
Three factors contributed to annual losses in IRPs for pensioners:
1. Shell waited until inflation increased by 32 % rather than 20% before making an
adjustment for those who retired in 1995. This delay also affected those who
retired in 1996-1998 (a time of substantial staff reductions and forced early
retirements at Shell). The Inflation Related Payment losses shown in the table
above do not reflect the additional losses suffered because of this payment timing
delay.
2. Instead of increasing pensions by the 6-16% needed to make up 50% of inflation,
the 2007 payments were much smaller ranging from 6-10% with some being even
smaller if you take into account the imposed maxima.
3. For the first time in the history of IRPs, maximum monthly adjustments were put
in place. The maxima were $100/mo for pre-1980 pensioners and $300/mo for
1980-1998 pensioners. These maxima added complexity and produced very
unequal results. In the past, Shell IRPs covered 50% of inflation for all
pensioners. Below are examples of how the 2007 method radically reduced
inflation protection for 1996 pensioners at three different pension levels. These
examples also illustrate the unequal impact of the 2007 method, which was not
limited to only those retiring in 1996.
Monthly Pension
$3000
$4000
$5000
2007 Payment
$300/mo
$300/mo
$300/mo
% Inflation Replaced
31
23
19
There are many other IRP issues and anomalies too numerous to cover in this
paper. For example, two people with the exact same pension who retired one year apart
received distinctively different adjustments. Using an annual pension of $36,000, an
individual retiring in 1979 would receive $1,200 per year in IRPs while an individual
retiring in 1980 would receive $2,160 even though they experienced the exact same
-6-
inflation. If our analysis is correct, there are many similar examples that seem to fail a
reasonable test of equity.
These IRP losses are very significant. Should Shell maintain this approach or
reduce IRPs even further; the loss in benefits would be unprecedented in the history of
Shell Oil Company. It is difficult to fathom why Shell has done this, especially without
clear, direct explanation. Many pensioners are profoundly disappointed and wonder what
to expect in the future. Similarly, some current employees have told us that this reduction
was not communicated to them nor to collective bargaining agents, both of whom have a
serious interest in this matter.
F. POTENTIAL IMPLICATIONS AND CONSEQUENCES OF IRP LOSSES
Here’s what we think:
1. Unless there are fair, justifiable reasons for this reduction in IRPs Shell could lose
the loyalty and goodwill of tens of thousands of pensioners and their spouses.
When the Company asks retires for support on items like the carbon tax; depletion
allowance; access to explore and develop restricted areas; and others matters,
pensioners happily and willingly support Shell. Shell pensioners are good public
relations ambassadors, but with these IRP changes, it is highly probable that
support and goodwill will erode if not totally vanish. In addition, significant
numbers of pensioners may become disgruntled former customers and adversaries
to Shell’s interests.
2. In the last several years, RDS has made billions of dollars in profits from its U.S.
investments. Yet, it has made a dramatic reduction in its decades-long Inflation
Related Payment practice to Shell Oil pensioners. In the political and public
domains, will this not be perceived as unfair treatment of U. S. workers by a
giant, foreign oil shareholder that does not apply the same reductions to its home
country pensioners?
3. As employees learn of the Company’s serious reduction of IRPs, they likely will:
a. demand a more competitive pension policy that allows them to take 100%
of their pension as a lump sum as competitors’ employees are able to do.
Also, they will be surprised to learn that the most senior Shell
management, like you, are able to take the majority of their pension as a
lump sum and have been doing so since the early 1990’s while they can
take nothing or a very small percentage of their pension as a lump sum.
b. take as much of their pensions as they can as a lump sum, perhaps with a
favorable discount rate to them. This will cause immediate payments from
the Shell Pension Trust rather than the long, slow delivery of pensions and
IRPs, which has greatly benefited Shell over years. These cash flow
considerations are not inconsequential. With a migration from monthly
-7-
pensions to lump sum payouts, there will be a significant loss of
investment income from the Shell Pension Trust.
4. A steadfast cornerstone of Shell Oil’s strength has been employees’ beliefs in
management’s integrity and commitment to be fair and equitable to employees
and pensioners. Employees and pensioners have felt that their interests were
important considerations in the deliberations of their leaders. In recent years,
some have begun to question the continued strength of this commitment to
fairness and equity. The 2007 IRP reductions, along with the failure to
communicate satisfactorily the reasons for the reductions, will reinforce this
sentiment.
5. In the future, the cost of IRPs will almost totally disappear because of the new
alternative pension formula offered in 1998 and the 4-5% mortality rate for
pensioners in the old defined benefit pension plan. It is hard to understand why
Shell Oil’s shareholder has created a contentious issue over a cost that will in time
just go away. This is especially troublesome given RDS’s enormous financial
success in the U.S.A.
6. Collective bargaining agents will become more concerned and knowledgeable
about IRPs and clearly see that they cannot rely upon Shell’s past practice and
good will regarding IRPs. After all, if Shell can unilaterally reduce IRPs now,
they may reduce them even further or eliminate them altogether. Union leaders
may seek protection for the employees they represent by collective bargaining. If
formal agreements for IRP’s are made, then formal financial booking and funding
must follow. Thus, Shell could end up having to do the very thing it would like to
avoid.
7. With good reason, pensioners could ask for a retroactive pension change. This
change would be a one-time option to take a lump sum in place of their monthly
pension and IRPs. Had employees thought Shell was going to back away from its
decades-old practice, they would probably have selected a lump sum option.
However, a lump sum was not an option for anyone who retired before about
1990, and after that date, the lump sum was limited to only that portion of the
pension paid from the BRP. Since Shell has changed the approach to IRPs, a onetime lump sum option could be a reasonable alternative to offset inflation. Of
course, this would have huge financial implications for Shell Oil and the Shell
Pension Trust. However, in the eyes of pensioners, it would be a reasonable
request, and rejection of this alternative would cause even more divisiveness.
8. By design, Shell has carefully communicated to help assure that it could
demonstrate that any IRPs granted were at the Company’s discretion. When
pension choice was implemented in 1998, Shell became more open in
communications about IRPs. Educational material told employees that IRPs had
been granted in the past at the discretion of the Company, there was no guarantee
that future payments would be granted, and the past payments approximated 50 %
-8-
of inflation. Since employees now faced Pension Choice, Shell had an obligation
to make employees aware of IRP practices so they could make an intelligent
pension plan choice. Also it was believed by Management that if this historical
practice substantially changed, Shell had an obligation to provide this information
to employees. In addition, at the time management felt there was a clear ethical
obligation to advise pensioners who depend so much on these IRPs. Is there new
legal advice or new Shell thinking in this area?
G. OUR REQUEST
Before we became pensioners, most of us knew of IRPs, but not all the details of
how the program worked. What we knew often came from grateful and trusting
pensioners. Employees and pensioners have appreciated and respected IRPs as a
reasonable alternative to much preferred lump sum payments not available from Shell.
Regrettably, the 2007 Inflation Related Payment approach has changed pensioners’
views, and there is great concern for the future. We ask for your help in putting this right
by returning to the pre-2007 IRP practices and by making fair restitution to those
pensioners who have experienced losses. Many Shell Oil Company pensioners are feeling
badly in need of your advocacy. We hope you will be there for us as we were for Shell
for so many years.
-9-