Lucent Discloses Pension Governance Process and Fund Performance 
- November 11, 2003
Following a request from the LRO, Lucent provided information on its pension governance process and the performance of the trust funds.




The following information was cleared by Lucent's General Counsel and Chief Financial Officer in response to a request from the LRO.  Lucent noted that it represents a level of disclosure far greater than required by law.   


1) How the Pension Governance Process Works:


The Board of Directors (composed of 11 directors, nine of whom are independent)


  • The Board of Directors sets the investment strategy for the pension fund, which includes setting the targeted asset allocation and distribution by asset class. This is, by far, the most important decision that is made about a pension fund.  Studies by pension experts over the years have confirmed that 90% of a pensionís performance is determined by the asset allocation.  The other 10% of performance is determined by the pension's performance within the specific investment categories set forth under the asset allocation.


  • The Board approves the funding and contribution policy, and the overall decision-making structure used to manage the pension trust.


         Board members have been briefed by outside legal counsel covering their fiduciary responsibilities regarding the pension trust, including the requirement that they make all decisions regarding the pension plan solely for the benefit of the plan participants.


         The Board appoints members of management to serve on the Pension and Benefit Investment Committee (PBIC) and oversees the Committeeís operations.


The Audit and Finance Committee of the Board (composed only of independent directors)


         Reviews and recommends changes to the Board for the funding policy and contributions to the pension plan.


         Monitors internal financial controls and asset performance.


  • Reviews annual external audits.


  • Periodically monitors performance


The Pension and Benefit Investment Committee (PBIC) (composed of members of Lucentís senior management who have expertise in Finance and/or Benefits)


  • The Board, operating under ERISA guidelines, delegates day-to-day oversight responsibility to the PBIC.


  • The PBIC monitors implementation of the asset allocation strategy set by the Board and the cost effectiveness of the investment program.


         The PBIC also monitors compliance with investment-related items including risk management policy, regulatory issues and internal control structure.


  • The PBIC has oversight responsibility over the Lucent Asset Management Corporation (LAMCO).


  • The PBIC does not decide asset allocation, make investments or hire investment managers.


Lucent Asset Management Corp (LAMCO is a separate wholly owned subsidiary staffed with investment professionals. The current Chief Investment Officer is the former chief investment officer of the Massachusetts State Pension Fund.)


         LAMCO staff members act as fiduciaries and are legally responsible to make all decisions for the sole benefit of the plan participants.


         The Chief Investment Officer reports/recommends to the PBIC on policy matters and establishes operating procedures for the LAMCO staff.


         The Chief Investment Officer hires and fires external investment managers.


         The LAMCO staff monitors the performance of external investment mangers, vendors and the master trustee.


         The LAMCO staff handles day-to-day implementation of the investment strategy set by the Board.


  • Since FY2000, the chief investment officer and the LAMCO staff have been on a compensation plan that is based solely on the performance of the pension not on Lucent's financial results.


         As a matter of policy, the LAMCO staff does not make direct investments in any company or venture, and does not specify investments; the external investment managers (hired by the chief investment officer and other LAMCO staff) have full discretion, within investment guidelines, to make the investments.


         Investment managers have the sole responsibility for deciding on any private or public equity investment.



2) How Has the Pension Been Performing?


We benchmark the performance of our pension against the following industry indexes:


  • Domestic equity is benchmarked against the Russell 3000 Index.


  • High Yield investments are benchmarked against the Citigroup High Yield Cash Pay Index.


  • Private Equity is benchmarked against a blend of Russell 3000 (71%) and Morgan Stanley Capital International (MSCI) World (29%) ex-US plus 500 basis points.


  • Real Estate investments are benchmarked against the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index.


  • Emerging Markets are benchmarked against MSCI Emerging Markets Free Index.


  • Fixed Income investments are benchmarked against the Citigroup Broad Investment Grade (BIG) Index through 8/30/2003 and the Citigroup Large Pension Fund (LPF) Index effective 9/01/03.


And the Lucent Total Fund Index is a weighted average return of Policy allocation (%) x benchmark for each asset class of investment.


While, like almost every other fund in the U.S., we do not publish and are not going to share our Board-directed asset allocation, we will give you the total fund performance against the total benchmark:


                                    Benchmark                Performance

                                                                        (Net of Fees)


FY1996                        13.12%                     14.13%

FY1997                        24.21                           27.63

FY1998                          2.10                             5.25

FY1999                        20.76                           21.22

FY2000                        12.37                           22.81

FY2001                      -17.26                         -15.66

FY2002                        -9.38                            -9.14

FY2003                        21.87                           18.21


Please note that we are slightly below benchmark this year due to private equity investments.  However, over the past five years private equity has outperformed the benchmark by 5.72%.


Pension investments need to be viewed over a longer term than a year to get a true picture of performance.  In fact, on a ten-year basis, against a total policy benchmark of 8.18%, the fund performed at 9.88%.  On a five-year basis against a total policy benchmark of 4.40%, we performed at 6.16%, more than 40% above benchmark.


While there are consulting companies that produce performance criteria against a universe of other corporate pension funds, they donít name the companies or their asset allocation, so we are unable to provide you with the comparison that you asked for against the top ten largest pension funds.  And the most meaningful measure of how the fund is being managed is how the investments did in the particular investment category i.e., domestic equity, fixed income, private equity, etc., versus the benchmark.



3) And Finally, Who are Our Investment Managers?


We polled several of our peer companies to see how they handled disclosure of pension investments.  The almost universal answer is that the only disclosure was in their IRS Form 5500 filing where corporations are required to list vendors paid more than $5,000 per year.  These filings can be found on-line by accessing the following Web site:  Our 2001 Form 5500 filing is posted there; the form 5500 for 2002 has been filed but is not yet available on that website, so I have attached it for your reference. The investment managers are clearly labeled in the filing.


As you said at the meeting, we certainly support the adoption of the new Financial Accounting Standards Board (FASB) rules and will clearly follow them.  But, we are comfortable that our present level of prudent governance provides both the oversight and the independence that retirees seek.



Pension Credits and Incentive Funding


As to your shareholder proposal on pension credits being excluded from the calculation in determining executive compensation, let me share the thoughts that will govern our response.


We believe that this proposal is based on a misunderstanding of how Lucent's performance-based compensation is calculated.


We link compensation for executive officers to the performance of the company (itís detailed in the proxy).  Our short-term and long-term incentive plans are based on achieving financial performance objectives that are set at the beginning of each year. In 2003, the target was based on operating income and it will again be based on operating income in 2004. Consistent with Generally Accepted Accounting Principles (GAAP), the pension credit is considered part of operating income for reporting financial results. 


Here are the important elements for purposes of compensation:


The pension credit is effectively established at the beginning of the year at the same time that operating income targets are set.  The asset return and discount rate assumptions that drive the pension credit calculation are fixed at the beginning of the year and remain fixed for both reporting and compensation purposes.  The assumptions are consistent with GAAP and other standards set forth by the Financial Accounting Standards Board.  These assumptions are reviewed by Lucent's Board through its Audit and Finance Committee (comprised entirely of independent directors) and are disclosed in our SEC filings.  So, the current governance process assures that the pension credit assumptions are not set in a discretionary manner that would benefit management as your proposal states.


Any changes in the pension credit resulting from adjustments in the pension-related benefits during the year are reviewed by the Board for purposes of determining compensation.  For example, this year the Board excluded the favorable operating income impact of the elimination of the death benefit in calculating bonuses.  Therefore, the pension credit was basically a neutral factor in determining bonuses.  


So, the company already does what your proposal is requesting.  I hope these replies further our dialogue.



Kathy Fitzgerald