Ireland: New model vital
Irish pension schemes must find new strategies to cope with effects of ageing population, says Conor Daly
A recent survey by Lane Clark & Peacock Ireland (LCP Ireland) illustrates the magnitude of the challenges faced by employers providing defined benefit pension schemes in Ireland. Surveying the 2008 accounts of the top 25 companies on the Irish Stock Exchange, along with four of the country's largest state-sponsored bodies, LCP Ireland estimates that these companies had a combined deficit of approximately €9bn at the end of October 2009. Not surprisingly the banking and state-sponsored sectors account for the majority of this deficit.
Irish pension schemes have been victims of the excesses of the Celtic Tiger. A recent OECD working paper showed Irish pension funds to be among the world's poorest in terms of investment performance in 2009. LCP Ireland's survey supports this finding, and shows how the level of equity exposure in these schemes was a major contributor to this poor performance.
The survey shows that the level of equity exposure in the schemes operated by the companies analysed was 65% in 2007, dropping to 55% in 2008. It is reasonable to conclude that most of this reduction was due to market falls rather than any proactive risk management by the managers of the schemes. There are a few notable exceptions, such as Smurfit Kappa and RTE, which the survey shows benefited from their lower-than-average exposure to equities and whose funding levels were therefore more resilient to the market falls.
LCP Ireland's survey focuses on the largest indigenous Irish companies. There are considerably more pension schemes in Ireland than this sample, many of significant size, such as those operated by private companies or those whose primary listing is outside Ireland. It is reasonable to assume that the survey is representative of the country's larger schemes, and illustrates the extent of the difficulties facing providers of defined benefit schemes.
It is clear that providers of defined benefit schemes in Ireland will need to rethink their pensions strategy. Many will review the situation and decide that their schemes are not sustainable. Some will potentially wind up, providing replacement defined contribution schemes. This will bring its own challenges with employees taking on investment risk and the potential inadequacy of the contribution rates to the replacement schemes.
Some of the larger employers may consider alternative forms of DB provision. In the banking and financial sector there has already been a move towards hybrid schemes, such as those provided by AIB and Bank of Ireland. The recent Budget announcement that a career-average scheme is to be provided for new joiners to the public sector is likely to increase interest in this type of model.
The career-average scheme model would have been ideal for Celtic Tiger Ireland as it would have helped control the impact of large salary increases on the funding position of pension schemes. Up to now, risk management by schemes primarily focused on the management of scheme assets. In the future, those who decide to maintain defined benefit schemes will have to focus on the liability-side risks and the career average model has significant in-built liability risk controls.
In addition to changes in the type of pension scheme provided for future public workers, also flagged in theBudget were changes to the minimum retirement age within the public sector scheme. Ireland, like most other European countries, is facing considerable demographic challenges as its population ages. As in the UK and elsewhere, it is likely that changes will be made not only to the retirement age for employees in the public sector but also to the state pension age. Any such changes will have reciprocal effects in the private sector as employees look to tie their retirement in with the commencement of their state pensions. Such moves are likely to reduce the cost of pension provision to employers.
The long awaited Pensions Framework document is expected in the first quarter of 2010. It is expected to outline the government's strategy for dealing with pension provision into the future. What is clear is that the current model is not sustainable. Just considering the legislative framework for defined benefit schemes, it was devised at a time when schemes were relatively immature, with working members exceeding retired members. Indeed, many schemes would have had no pensioners. This is clearly no longer the case, with many schemes now having more pensioners than contributing members. This type of membership profile reduces the flexibility of trustees to deal with deficits.
Pensions legislation and Pensions Board guidelines, unfortunately, are not helping the situation and are further restricting the options available to trustees and employers. At a time when companies are facing broader economic challenges, particularly in relation to the allocation of cash flow, this inflexibility is encouraging the consideration of the extreme options of closing to future accrual or wind-up, even among the most paternalistic of employers.
Pension provision in Ireland is at a crossroads. LCP Ireland's recent survey shows just how poorly funded the majority of defined benefit schemes are. It also shows the extent to which these schemes are at the mercy of the markets. With less than 60% of the working population in any pension scheme, the last thing that the government can afford is for those employers who are making pension provision for their employees to cease doing so.
It can only be hoped that a greater focus on pension provision will encourage more employees to take responsibility for their retirement income. For many years, employees and their unions have been advocating the provision of defined benefit pension schemes and the guarantees associated with it. Unfortunately, many defined benefit members are now realising that their so-called ‘guaranteed pension' was only as guaranteed as the employer standing behind it. In extreme cases such as at Waterford Glass this might have meant little or no retirement pension, even though some members made contributions for up to 40 years.
LCP Ireland's survey shows that maintaining these defined benefit guarantees will be a considerable demand in Ireland.
Conor Daly is a partner at LCP Ireland in Dublin