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Irish MFS needs increase from 'junk' bond level

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  • Irish MFS needs increase from 'junk' bond level

IRELAND - The minimum funding standard (MFS) for defined benefit (DB) pensions needs to be revised "as a matter of urgency" as it provides the same level of asset backing as a 'junk' bond, the Statistical & Social Inquiry Society of Ireland (SSISI) has warned.

In a paper published by the SSISI, entitled 'Pension Insecurity in Ireland', Michael Moloney and Shane Whelan from University College Dublin claimed the current regulatory regime of occupational and private pensions is "weak" and offers "inadequate security".

The report pointed out "there is much confusion over the cost of pensions" and so adopted a 'fair value' approach in its evaluation of the MFS, and its analysis of possible solutions for improving security for pensions.

Moloney and Whelan analysed the options of making the fair value of pension entitlements a debt on the employer and the possibility of establishing a protection fund financed by the pension industry, but admitted they had found "no fully satisfactory way of improving the security of members in the short- to medium-term".

Private pension provision in Ireland is subsidised by the state through tax relief on contributions, which the paper claimed is "of the same order of magnitude as the cost of the state pensions in a year", and authors argued the state is not getting value for money.

Instead, it claimed to demonstrate a "fundamental failure of the private sector to provide adequate security for pension saving" as regulation requires only partial asset-backing for benefit promises, and "has little enforcing power for even that minimum standard" with no support from the sponsoring employer's balance sheet.

Findings from the research suggested "the need for some level of asset-backing for future pension commitments is obvious given the corporate incentive to underfund", as it said pension promises from private DB schemes - "if 100% funded on the MFS" - have a similar security to a sub-investment grade corporate bond, sometimes given the derogative label of 'junk' bond.

It added: "It cannot be reasonably maintained that investing all of one's pension savings in a junk bond is prudent or wise. Yet this is in effect what the state has done by contracting out pension provision to the private sector and monitoring it with such a weak regulatory framework."

The SSISI paper also analysed the option of making pension deficits a debt on the employer, as in the UK, but warned while this would give improved security to DB members, it "is not materially addressing the issue" as the MFS is currently too low a standard.

The authors suggested the MFS standard should be increased to "no less than 50% of the fair value of a riskless pension", although this can be introduced "pragmatically" to alleviate the increased cost burden,while any deficit under the revised MFS should be made a debt on the sponsoring employer "with immediate effect".

The paper meanwhile rejected the idea of introducing a protection fund financed by the occupational industry, similar to the PPF in the UK, because "firms in the industry do not have the surplus to make up for each others' deficits", and even if they did the operation of such an insurance scheme would effectively be a transfer of assets from one sponsoring employer to another.

In addition, the research warned the pre-conditions necessary for establishing such a fund are not in place, as it claimed "the pensions industry is currently incentivised to take investment risk and, in Ireland, pension funds have the highest exposure to equities of any OECD country". 

"Simply put, it is foolhardy to insure a scheme when it is being rewarded for risk-taking," stated the report.

Instead, in addition to the revision of the MFS and making employers responsible for deficits, the authors called for a number of policy actions "as a matter of urgency", including:

The Pensions Board should be given greater powers to enforce funding to MFS level; Rules on prioritising assets for benefit payments at wind-up should be revised to give more security to those closer to retirement; Pressure to establish a pension protection fund should be resisted, and Members should be given an annual update on the funding level of DB benefits.

However, the report admitted: "Practically, though, the security of such pension promises cannot be made satisfactorily secure in the short- to medium-term."

It pointed out the state pension was established 100 years ago "after inadequate reserving and investment mismatch created solvency problems in friendly societies and other provident institutions", and added "given the failure of the private sector to develop adequate structures in the meantime, the state must play an even greater role over the next 100 years". 

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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