DC benefits both sides
Banks and financial institutions have been in the vanguard of the move to DC pension plans in Ireland. AIB Group closed its DB scheme to new entrants at the end of 1997 and launched a DC scheme in 1998.
The DC scheme now has almost 5,000 active members in Ireland and 1,000 in the UK and Northern Ireland. At the end of last year, the scheme had funds totalling E54m, compared with the E2.2bn in the DB scheme.
The boom in the Irish economy has driven the development of AIB’s DC scheme much faster than expected, says Colum McDonald, group pensions executive at AIB Group.
“It did create some problems in terms of administration because there’s a lot more involved in the DC side than the DB – something that shouldn’t be forgotten by any employer thinking of switching to a DC scheme.”
The attraction of a DC plan for AIB was that it gave them more control over present and future costs, says McDonald. “From the bank’s point of view, the attraction of a DC scheme was that it took the liability and the uncertainty off the balance sheet and enabled it to budget more precisely. We also thought that if we were to bring in a wider range of flexible benefits it would be much better to do that with a DC scheme, because it’s easier to work out what the costs are.”
There were also clear benefits for the employees, he says. “We felt that a DC scheme was better aligned to the more modern sort of working, with people moving to other jobs. The two advantages of DC are being able to take all your benefits, unlike the distortions that arise in the DB scheme, and being able to take more responsibility over your pension and deciding how much risk you want to take.”
The DC scheme has been designed to replicate the popular DB scheme, McDonald says. “We started off on the basis that the target would be to replicate the benefits in the DB scheme, but obviously with no guarantees about fund performance and annuity rates. We decided what funding would be required based on our assumptions regarding the usual mix of bonds and equities that a person would normally have in a fund.”
AIB makes a contribution of 10% to the DC scheme. “That’s much higher than the industry average of 5%. It’s perfectly obvious that 5% is not going to produce a good pension – that is, two thirds of your basic salary after 40 years’ service.”
Employees have a variety of funds to choose from, ranging from cash, corporate bonds, a ‘safeguard fund’ (a semi-guaranteed tracker fund), a managed fund (a mix of equity, bonds and property) and 100% equity fund.
The fall in equity market values has dampened enthusiasm for the 100% equity fund, McDonald notes: “We find that in most cases that people have switched into the managed fund. But they have only switched new contributions. They have left the money that was already there in the 100% equity funds.”
AIB uses its own investment managers, AIB Investment Management in Ireland and AIB Govett in the UK to manage the DC fund. “We feel that they’ve got a wide enough range to meet out requirements. If we wanted to go outside the trustees would have no objection. But we have not needed to.”
One advantage of AIB’s DC scheme apropos the group’s DB scheme is that, like most DC schemes, it is not state-integrated. Integrated schemes take account of contributions and benefits of both the social welfare and occupational systems as a whole.
“In the DC scheme, the contributions are based upon the total salary. So, in theory anyway the people in the DC scheme should get a better pension, because if everything were to work out according to our actuarial assumptions you’d actually get two thirds of your total salary plus your state pension.”
The DC scheme is unlikely to be affected by the introduction of PRSAs, says McDonald. Members of the pension scheme have shown little interest in contract-based schemes. “When stakeholder came along in the UK, we wondered whether to close down the DC scheme and change to stakeholder. We had quite a reasonable education campaign among staff to tell them about it. But, at the end of the day, not one person opted to have a stakeholder concurrently. It just didn’t happen.”
This has ruled out any possibility of a switch to PRSA contracts when the scheme becomes operational next year. “If that had worked out we would have done exactly the same thing with PRSA and switched from a DC scheme to a PRSA scheme,” McDonald says. However, the chances are now that AIB will retain its DC scheme for the foreseeable future.