Ireland: More rivers to cross
Philip Shier of Hewitt Associates looks ahead to another difficult year for Irish pension funds
In common with most other countries, 2009 was a difficult year for all of those involved with Irish pension schemes - members, trustees, sponsoring employers and advisers. Although equity markets recovered from their March lows to post positive results for the year, the impact on the funding shortfalls in defined benefit (DB) schemes was dampened as liabilities also increased with falling bond yields.
With about 90% of schemes failing to satisfy the statutory funding standard at the start of the year, trustees were faced with the task of putting together a funding proposal to address the deficit, in circumstances where the sponsoring employers were unable to make the substantial cash contributions needed to restore solvency over a reasonable period. In recognition of this, the Pensions Board relaxed its requirements in relation to the deadlines for submission of funding proposals and the maximum recovery period that it would be prepared to approve.
The Irish Association of Pension Funds and the Society of Actuaries in Ireland made a joint submission to government at the end of 2008 which put forward four steps to be taken to address the difficulties arising on the wind-up of schemes (where the employer might also be insolvent) and the longer-term issues of sustainability and security for ongoing schemes. These were:
• Pensioner priority on wind-up should be limited. Under the existing provisions, pensions in payment, including future guaranteed indexation, had to be fully secured before any assets were applied to other members, which in some cases meant that all of the available assets on wind-up would have been used for pensioners.
• There should be a mechanism to alter the accrued benefits of active and deferred members in order to sustain the scheme.
• A debt on employer provision should be introduced to prevent solvent employers abandoning their pension commitments.
• The state should offer an annuity system where schemes wind up in deficit and employers are insolvent. This would allow the trustees to secure pensions at a lower cost than available from commercial annuity providers, thus reducing or eliminating pensioner shortfalls where these exist, and where pensions can be secured in full, increasing the amount of assets available for distribution to other categories.
Three of these measures were subsequently introduced in the Social Welfare and Pensions Act 2009, which provided for:
• The establishment of a Pensions Insolvency Payment Scheme (PIPS) to provide annuities in the case of "double insolvency".
• Increased powers under the rarely-used Section 50 of the Pensions Act and a new Section 50A which would permit reduction of accrued rights (subject to Pensions Board approval).
• A reduction in priority for post-retirement pension increases which, for wind-ups after 29 April 2009, are not provided until all members (pensioner, active and deferred) have received their full benefits, excluding such increases.
The PIPS framework has not yet been established, but its introduction and the change in priority of pension increases will enable a somewhat more equitable allocation of available assets on wind-up. The government has not introduced "debt on employer" requirements due to concerns that in the current difficult business environment this might force employers out of business, but this is likely to remain on the longer-term agenda.
It is a testament to the commitment of employers and the support of members and trade unions for the concept of DB provision that relatively few employers have wound up their schemes but have worked with trustees, actuaries and unions to put together a funding proposal to enable the scheme to continue, albeit with increased member contributions and perhaps reduced benefits (or in extreme cases no further benefit accrual). The Pensions Board requires that any reductions to accrued benefits using a Section 50 order must result in a sustainable and affordable pension scheme for the future, and it has recently published further guidelines which include stress tests to assess the ability of the scheme to withstand equity falls and interest rate reductions, and the payment of contribution rates assessed on a basis which does not take advance credit for equity outperformance.
It is likely that in some cases where Section 50 orders were being contemplated, it will ultimately prove impossible to reach a viable solution and that the scheme will be wound up with the employer offering a defined contribution arrangement for future service. For stronger employers where wind-up of the defined benefit scheme is not contemplated, risk management will be the key issue, and this may involve benefit changes as well as investment strategy issues. Employers and trustees will need to work closely together to develop solutions which are more focused on risk management to help ensure the continuation of these arrangements.
While the focus has understandably been on the short term, the government must address pension policy in the long term, both in relation to state-provided pensions (including those for current and retired public sector employees) and occupational or personal pensions. The Green Paper consultation exercise which concluded in May 2008 sought views on a wide range of issues including:
• Social welfare pension reform;
• Increasing pension coverage;
• Funding standards;
• Public service pensions; and
• Flexibility of retirement age.
The minister for social and family affairs recently indicated that the Green Paper or framework for pension will be published in the next few months. In his Budget speech on 9 December, the minister for finance, Brian Lennihan, stated that the tax treatment of pensions will be considered as part of this process, but indicated that he accepted the recommendations of the Commission on Taxation that lump sums below €200,000 should not be taxed. This suggests that there will be a tax charge on amounts above this level, and it is also likely that steps will be taken to introduce the proposed uniform 33% rate of tax relief (compared with the current system of relief at the marginal rate) on pension contributions. This might encourage those on the standard rate of 20% tax to increase contributions to pensions but will reduce the incentive for those subject to higher rate tax (41%) to do so. The Hewitt view is that many lower-paid workers will not contribute higher amounts to their pension and avail themselves of this increase in relief as they cannot afford to do so. Equally, we believe that higher-rate tax payers might stop saving for retirement through the traditional route, as the tax relief received on contributions is lower than the tax paid when in receipt of pension income.
The major policy announcement in the Budget related to public service pensions, with a career average scheme to be introduced in 2010 for all new recruits to the public service, with a pension age of 66. The minister also indicated that he would review the ‘pay parity' basis for increases to public service pensions, noting that a change to CPI-linked increases would reduce the accrued liability for public service pensions from €108bn to €87bn, and confirming that pending the outcome of that review, he would not apply the public service pay cuts announced in the Budget to pensions already in payment. These cuts will also not be applied for public servants retiring in 2010.
Government policy on pensions will also be influenced by developments in the EU, following the appointment of Michel Barnier from France as Commissioner for the internal market, in succession to Charlie McCreevy, and the establishment of new supervisory bodies which are likely to lead to greater harmonisation of pension provision and regulation throughout Europe.
The year ahead is likely to prove another challenging one for all of those with responsibility for pension provision in Ireland, be they government, regulators, employers, trustees or advisers but it is to be hoped that lessons learned from the difficulties of the last couple of years will enable a more robust system to be established to ensure an appropriate level of retirement income for all in the future.
Philip Shier is senior actuarial consultant at Hewitt Associates in Dublin and a past president of the Society of Actuaries in Ireland