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Partial funding for public pensions

The full funding of public sector pensions in Ireland has been rejected as a solution to the massive problems posed by civil service and other public pensions set to absorb an growing proportion of the country’s GDP in the years ahead- increasing from 1.6% of GDP in 1997 to a peak of 2.4% in 30 years’ time. The recently issued report* of the Commission on Public Service Pensions concludes that “full funding is not practical, necessary or advantageous”.
But it accepts the case for partial funding, as a means of “ensuring improved transparency and discipline in public service pensions costs, smoothing the expected peak in the pensions bill and bringing a balanced approach into the long-term financing of pension costs”.
The commission, the first comprehensive public review of the issues in Ireland, was set up in 1996 and was chaired by Dermot McAleese, professor of economics at Trinity College Dublin.
Commenting on the findings, he says: “Something needs to be done about public sector pensions, as the state’s pensions bill for these under the current pay-as-you-go system is going to increase very markedly – up fourfold over the next 30 years. It is just Ir£700m (£875m) annually now and it is going to go up to Ir£2 to £3bn, which is a very substantial increase. We recommend there should be a fund put aside to finance it.”
According to the report if a formal public service pension fund were to be established along private sector lines, an initial £990m contribution at 1997 salary rates equal to 19% of pensionable pay would be needed, in addition to the current PAYG spend on pensions of £825m in that year. In addition, the state would have to set aside a fund of £25bn to meet its accrued pensions liabilities.
But the report points out that trying to moved to a fully funded approach on phased basis for just a certain group, such as new entrants, would be of “little value” in reducing the state’s pension spend in the years of expected peak cost in the years 2017 to 2032, because of the simultaneous double payment of current pensions and pensions contributions.
“We did not think that full funding did anything to alleviate the costs,” says McAleese. In fact, full funding would exacerbate the peak in pensions costs in the next 15 to 30 years, according to the report. “Nor did we think that full funding is necessarily better than PAYG.”
He continues: “But we did think that given the huge rise in costs we should go the route of partial funding for the hump and to get over that part of the slope. Once the system has become stabilised, then the PAYG method with all its pros and cons could be lived with quite comfortably.”
The report says such a mixed financing approach would concentrate attention on to the costs of pensions as in PAYG systems benefits tend to be the main focus. Both civil servants and the state would be more conscious of the real costs of recruitment. A partial fund would help smooth the pensions bill in the future and reduce risk from reliance on solely the PAYG system.
Any fund should be structured to maximise investment returns, among its other objectives says the commission in the report, which discusses whether it should be on the lines of a budgetary reserve (buffer) fund or be a pension fund, modeled on the lines of a private sector occupational fund, run on a prudent basis, with actuarial valuations and so on.
If the only objective of a public service pension fund was to meet the peak in government pension costs, then a buffer fund would be ideal, says the report. But the commission notes that under the EU’s ‘Stablility and growth pact’, there could be problems when the ‘General Government Balance’(GGB) is taken into account. “If a fund for public service pensions were established as part of a government reserve funds, payments into a fund when made would not be treated as expenditure in calculating the GGB and so would not reduce the present GGB surplus; and later withdrawals to meet pensions costs, when made, would not be regarded as receipts and so would not improve the GGB at that time,”says the report. But a properly constituted pension fund would mean that state contributions and future use of payments from the fund would directly assist the country’s GGB.
So the report opts for such a fund closely replicating private pension funds and recommends that it be established to meet the future costs of public service pension increases. The accrued liability in 1997 for future increases in pensions in payment (linked to earnings in the public sector) amounted to £4.2bn at 2% inflation, or £5bn at 3% on a discounted present value basis. The funding rate for this is 5.1% of gross salaries, equivalent to around £250m in 1997, at 2% inflation.
The report looks at different
modelling scenarios, depending on the amount the government contributes as lump sums towards meeting the past service liability in full or in part. So if the full £4.2bn was paid in a fund of £13bn would be available in 2012, or £25bn by 2047, which could trim back expenditures from 2.4% of GDP in 2017 to 2032 to 2.2%, and maintain an 0.3% of GDNP gap to 2047.
Looking at what the government had set aside as part of the National Pensions Reserve Fund’s (NPRF) assets already, designed to meet social welfare and public sector pension commitments in a ratio of 2:1. The amounts of assets in the NPRF already and the annual contribution envisaged would mean no additional costs to the state in backdating the fund to the beginning of 1999 and re-classifying its pre-funding payments as well. “We tried to tie in our approach with what already was being done with the NPRF and the 1% of GDP being allocated to this.”

In addition, the commission recommends that new entrants to the public sector be required to pay 1% per annum of salary for the increase in salary benefit. “We felt pensioners should have parity in line with earnings in the public sector to protect their standard of living,” says McAleese. But since this is not available in the private sector state employees should pay for this privilege. “We also suggested a public services earnings index to calculate the correct rates for this.”
Among the wide range of other areas the commission examined was that of retirement age in the public sector. “We felt there should be a definite age where people retire, though the trade union members took a different stance on this. But we drew a distinction between continuing to work which is to be encouraged if people want to and to have a right to stay in their job. In general we thought it bad to stay in your job over age 65. There should be a cut-off date where the state does not have to give reasons for letting someone go.”
Overall, the commission felt there had been very poor communication of the public sector pension benefits and suggested this be remedied, with in particular information about how to top up benefits by additional voluntary contributions.
In any commission’s work there are two aspects, says McAleese. “One part is the education element getting ideas over. The other are the things that need changing.
“A good pension scheme is very important in the public sector where we want to to hire good people and to keep pensions out of the industrial relations negotiation area as much as we can. If we have managed to restore some of the balance through the report, which has just a few simple ideas really, I will be satisfied. It is an evolutionary report, not a revolutionary one in any sense.” IPE
* ‘Commission on public service pensions’ final report (Pn9209), published by The Stationery Office in Dublin (£19.05)

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