Ireland returns to the funding standard
With the imminent reintroduction of the funding standard in Ireland, as well as new guidelines on sovereign annuities, the pension industry is to witness some significant changes.
Pension schemes had been granted a reprieve for a number of years with the suspension of funding guidelines by the regulator, a pragmatic approach taken as a result of the financial crisis. Recent numbers by the Pensions Board estimated that up to three-quarters of funds would be unable to fulfil minimum requirements, resulting in either high recovery payments or, in absence of debt upon the employer regulation, the winding up of funds.
However, new guidelines on sovereign annuities may offer an opportunity for trustees to reduce liabilities, with partial risk-transfers to insurance companies becoming more affordable.
The new annuities, no longer strictly linked to AAA-rated government debt, such as Bunds, will allow exposure to any euro-zone government issuance. This is on the understanding that on a country defaulting, the payments are not required to be covered by insurance.
The head of policy at the Irish Association of Pension Funds, Jerry Moriarty admits that this opens up problems for trustees, who on the one hand will be looking to reduce liabilities, while on the other have to weight the de-risking opportunities up with their responsibility to safeguard member's benefits at all costs.
Moriarty forsees a partial buy-in market growing over the next couple of years, with changes in insolvency legislation meaning pensioners will no longer be granted preferential treatment over deferred and active members. As a result, trustees may explore the option of buying out parts of each member's future contribution payment.
Declan Keena of Irish pension consultancy Invesco, however, warns of one of the potential impacts of buying out risk through use of the new annuities. "I say buy-out because if the pensioner liabilities are bought-in and there is a sovereign default, the deficit will fall back on the pension plan," he says.
However, unlike Moriarty, who admits that the new funding standard was "in the area" of Solvency II with an emphasis on increasing capital buffers gradually by 2022, Keena believes that the additional capital would only be needed if schemes continue to invest in high-risk assets such as equities.
The country's funds will be given a three year grace period during which the previous funding standard will be reinstated, with just over 11 years to achieve adequate funding levels under the new guidelines.
Keena argues: "I believe that over the next decade there will be a significant shift towards a far greater holding in bonds, which when coupled with the use of sovereign annuities to value pensioners may not lead to a significant increase in the overall reserves."
Proposals put out to consultation earlier in the year indicated that a scheme's capital buffer would have to absorb a 20% fall in equity values, in addition to a 1% drop in bond yields and a 0.5% increase in inflation - proving Keena's point that the capital buffer would be entirely dependent on the level of exposure to the stock market enjoyed by the fund.
While the new funding regulations could be viewed as a backdoor introduction of Solvency II, coupled with the sovereign annuities it equates to an environment where trustees will be better able to address risk - with Moriarty indicating that once the introduction of longer-dated Irish bonds becomes feasible, the IAPF would continue its support for issuance longer than ten years.