Ireland: A long game in pensions
Christine Senior assesses the roller-coaster of Irish pensions legislation and regulation
Change has been a watchword for Irish pensions over the last year. And more is to come. Further proposals will be included in the forthcoming National Pensions Framework, but what it will contain is far from clear. The framework is a much delayed response to the 2007 Green Paper - a root and branch rethink of pensions across the board - but with a particular emphasis on improving pensions coverage.
Feedback to the Green Paper was published the following year, with little consensus on the way forward from the industry. But the economic and financial climate has undergone cataclysmic changes since 2007, hence the delayed response, and the uncertainty over the outcome.
Government attempts earlier in the decade to raise pensions coverage with the introduction of Personal Retirement Savings Accounts (PRSAs) had failed to raise coverage much above the 50% level. Whether or not an element of compulsion should be introduced into second pillar pension provision was a key focus of the Green Paper.
One of the dilemmas was whether the second pillar should be made compulsory or whether first pillar pensions should be increased, financed by a rise in national insurance contributions. Compulsion looks unlikely. Philip Shier, senior actuary at Hewitt Associates in Dublin, thinks politicians favour a ‘soft mandatory' or auto-enrolment arrangement.
"There is concern making pensions compulsory will be seen by employers and workers as a further tax on income at a time when life is difficult," he says. "The likely situation if they do proceed would be to have something on an auto enrolment basis and assume the forces of inertia will mean 60-80% of people will stay in the arrangements to which a certain a certain lowish level of employer/employee contribution would be mandatory."
One option is the so-called kick-start arrangement. Eoin Fahy, chief economist at KBC Asset Management, says: "The kick-start option is the notion that you must contribute for the first three, five or 10 years after you start working then you can opt out. It's a variant on mandatory. The idea is once you get into the habit you are likely to continue. The biggest problem is trying to get people to start saving."
One subject for inclusion in the framework has already been flagged up. In early December's Budget, proposed tax changes to pension contributions were outlined. In a bid to spread tax relief more equitably across the population, a restructuring of the basis of relief is proposed, introducing a uniform rate, possibly of 33%, on all contributions, regardless of whether contributors are higher or standard rate tax payers. This was first mooted by a Commission on Taxation earlier in 2009.
The move is, however, contentious. Three influential organisations - the Irish Association of Pension Funds, the Irish Insurance Federation and the Irish Brokers Association - have all condemned the plan. One source of concern is that higher rate tax payers will no longer feel incentivised to contribute to pensions, if tax benefits are cut.
"A higher rate tax payer would be paying into a pension and getting tax relief at a lower rate rather than potentially they would be paying on the pension when they draw it down," says Martin Haugh, a partner at LCP in Dublin. "It reduces the incentive for higher rate tax payers to pay into pension schemes. And as higher rate tax kicks in around €30,000 the argument is not all people who pay higher rate tax are wealthy."
This is not the only tax blow to pensions. A proposed levy would hit lump sum payments over €200,000, although the rate is unclear. Currently lump sum payments at retirement are all tax free.
Whatever the outcome of the Pensions Framework, any measures are unlikely to be implemented quickly. Mary Hanafin, the minister for social and family affairs, has stated that reforms might not be made before 2014.
Other developments over the course of 2009 were driven by events. The high profile insolvency of Waterford Wedgwood in January and the consequent losses to pension scheme members provoked a re-examination of the rules governing wind-ups in the case of employer insolvency. At the time of the luxury goods maker's collapse, active and deferred members in schemes which offered guaranteed pension increases suffered greatly in comparison to pensioners, whose pensions and future pension increases had priority. Only after these were covered would any remaining cash be allocated to actives and deferreds.
The Social Welfare and Pension Act of April last year changed priorities for schemes offering guaranteed increases to give a more equitable distribution of assets in wind-ups. Pensioners still get priority for pensions in payment, but only at current levels, leaving more assets available to cover accruals for the rest of the membership.
Another government response aimed at making wind-ups fairer to all stakeholders was the establishment of a Pensions Insolvency Payment Scheme (PIPS). This allows trustees of a scheme winding up through employer insolvency to buy annuities from the government at rates substantially below market rates offered by insurance companies. From the government's perspective the system is meant to be cost neutral, although some in the industry are sceptical that this will really be the case. Money saved on providing annuities means more cash will be available to provide for the pensions of active and deferred members. No schemes have so far taken advantage of PIPS but some are in the process of winding up and could potentially use it.
PIPS has its detractors. In particular IBEC, the organisation that represents employers, thinks it doesn't go far enough.
"It's helpful but limited," says Marie Daly, head of legal and regulatory affairs at IBEC. "We would prefer to see it expanded so the criterion of insolvent company wouldn't have to apply. If a scheme is insolvent we think that should be sufficient. The state should offer members that annuity regardless of whether their employer is also insolvent. We think unless you extend PIPS it's not going to have that much of an impact."
It's likely the vast majority of Irish pension schemes do not meet the funding standard. The Social Welfare and Pension Act also allowed greater flexibility to schemes that failed to meet the funding standard to restructure. Under the new rules pension schemes can spread the pain of benefit cuts among all scheme members. Although pensioners' current level of pension is protected, future increases will not be.
Schemes planning to implement benefit reductions have to submit so-called Section 50 proposals. In November the Pensions Board issued further guidance on these, which caused something of a stir. The Board said any proposals would need to withstand a stress test of a fall of equity values of 15% and a simultaneous reduction of interest rates of 0.5%.
"We were saying if you are going to be putting in a section 50 proposal to us, make sure it's realistic," said David Malone, head of information at the Pensions Board. "You don't want to be coming back in a couple of years to reduce benefits further. There has been an overexposure in some schemes to equities and that has to be addressed. Sitting back and hoping for the premium on high levels of equity investment is not the most prudent way to be running a scheme. If you are making a proposal to the board it must be based on well-thought-out structures that have sustainability."
Unlike in the UK, unless schemes have guarantees, sponsoring companies carry no responsibility to back their pension schemes. They have a right to wind up schemes in deficit without making good the shortfall. And with no pension protection fund, members are at serious risk of losses. Trade unions claim that this is a breach of European law, and have lobbied for reform.
"The government recognises that it doesn't have any protection in place that it's expected to have and the unions recognise, if they need to, they can probably press the government to do something," says Shier.
Shier says the key issue is the funding standard and whether or not it will be amended. "I think it more likely the funding standard would be made stricter, partly because it hasn't worked. A lot of schemes have failed to meet the standard and, indeed, schemes have wound up in deficit where apparently the standard had been satisfied perhaps a year ago."
Generous public sector pensions which are a drain on the public purse have been a source of concern. Another reform introduced by the December Budget was a new form of public service pension which will cut costs. From 2010, all new civil service recruits will be eligible for a career average salary scheme rather than the existing final salary scheme. Their minimum pension age will rise from 65 to 66 and then be linked to increases in the state pension age.
Finance minister Brian Lenihan has also proposed linking public sector pension increases to inflation rather than to public sector salary increases, which he said would reduce the cost by around 20%.
"It would bring public sector pensions more in line with private sector pensions which pay inflation at best in current circumstances," says Fahy. "Many leave inflation payments to trustees' discretion and many aren't paying them now because the situation of pensions is so dire."
But the proposal is certain to be politically contentious. Public servants are unlikely to accept it without a fight.