Ireland: Salvation stalling
In common with defined benefit schemes across Europe, Ireland's are facing an existential crisis, with underfunding and closures widespread. New legislation to aid the industry was promised, but a year later has failed to materialise, finds Jonathan Williams
Since the financial crisis began, Irish pension schemes have been facing challenges not uncommon across the rest of the world. Volatile equity markets caused returns to diminish, leading to severe underfunding.
To address these issues and others, the government promised structural reforms that would change the framework underlying the country's defined benefit (DB) schemes. In March 2010, details were announced as part of the National Pensions Framework. This was the result of almost two-and-a-half years of consultations. Yet almost a year later, the industry is no closer to learning details of these new guidelines designed to save it from collapse.
This is somewhat surprising, considering the enthusiasm with which the former taoiseach Bertie Ahern called on the industry to engage with the initial Green Paper on Pensions in October 2007, saying that the country must engage with the issue, "not sleepwalk towards a major pensions crisis".
The sentiment was echoed by current Taoiseach Brian Cowen, minister for finance in Ahern's cabinet, who insisted that the issue was not just about pensions, and was rather about the whole of the country, the people's expectations, and about hopes for its children. The outcome is that after three years, very little has changed for DB schemes.
Asked about the reforms, the Irish Association of Pension Funds' (IAPF) director of policy Jerry Moriarty remains uncertain: "That's the part that is really a bit unclear - what is really envisaged?"
The proposals outlined a number of key changes, including a shift away from traditional final salary arrangements, and a suggestion that risk-sharing should be introduced by allowing investment losses to be reflected in lower benefit payments, as well fixed contribution rates for both employees and employers, as is already common in defined contribution (DC) schemes.
Moriarty believes that the latter point is key, with scheme designs aiming to emulate the best parts of DC, while still leaving in place certain paternal aspects of DB schemes.
"I think what they are trying to do is catch some of the benefits of DC, such as the sharing of risk, and the collective investment approach that goes into DB with some of the certainties you get DC around contribution levels, which is obviously quite important to employers," he says.
Similar approaches have been mooted in the UK, where politicians were involved in discussions on hybrid schemes during the depths of the recession.
The notion suggested in the Framework - letting benefits reflect the strength or weakness of a scheme's return in a given year - is also not new, with voluntary indexation and rights cuts often cited as one of the reasons the Dutch pension system remains sustainable, notwithstanding how unpopular the latter measure might be at times.
Emma Watkins, head of relationship management at MetLife Assurance sees indexation as one of the possible avenues. She believes that suggestions for a core benefit and additional benefit payments could help solve funding shortfalls.
"For example, this could take the form of limiting revaluation and pension increases only to years when a positive investment return was achieved, with little or no increases being given in years of negative return."
Watkins believes the government would support such moves, alongside the already more lenient timetables granted by the Pensions Board, for regaining a stable funding position.
This shift towards a system of core benefits, with additional benefits paid if affordable, could also lead to a change in the tactical asset allocation most schemes employ, says Philip Shier, an actuary at Aon Hewitt. "It seems likely that the new model will lead to a less risky asset allocation - indeed, even with the existing DB model, there will probably be less risk appetite than before.
"This may lead to higher allocations not only to bonds but to alternative assets such as commodities to provide greater diversification and hence lower volatility," Shier says further.
Others argue that the proposed changes do not go far enough. Martin Haugh, partner at LCP in Dublin, calling the reforms outlined in the NPF "rather limited". He welcomes others, such as the introduction of the sovereign annuity, announced by the government in December's National Recovery Plan, as more important.
"The opportunity is there for real and beneficial change. However, I would be concerned that if this legislation is rushed or not fully thought out it will do more damage than good," he said.
Sovereign annuities were introduced following proposals put forward by the IAPF and the Society of Actuaries as another way of addressing funding shortfalls. When currently buying an annuity, Irish schemes must measure the cost against the yields of euro-zone bonds, such as the German Bund and the French OATs, with lower yields making the acquisition of annuities more expensive and often pricing them out of the market when it comes to buyouts.
Once the National Treasury Management Agency (NTMA), which also oversees the National Pension Reserve Fund, begins issuance of these new, longer-term bonds, it will be possible to use Irish long-dated bonds as a basis for any such transaction. As these historically offer higher yields than other euro-zone rivals, it will immediately make buyouts more affordable.
Moriarty believes that schemes will be able to benefit from the reduction in funding standard deficit that comes with the changeover, but cautions that trustees will have a number of issues to consider beforehand, as both the structure of the bonds and their coupon are unknown. "With the bond markets being still somewhat unstable, I think it's something trustees are going to have to think long and hard about," he argues.
Haugh is less pessimistic, believing that the sovereign bond and its annuity could reinvigorate a stagnated buyout market in the country.
"It does exist - technically, you can buy out. But it's particularly expensive. If this now allows in some way for schemes to discharge their liabilities to Irish bond yields, which are substantially cheaper - we estimate up to 30% cheaper - then that would make buyouts particularly attractive. It could kick-start some buyout activity in Ireland."
This of course has drawbacks for the survival of DB schemes, as Watkins notes. "[Buyouts] may also increase the speed with which DB schemes are closed and wound-up in preference for future DC benefits for staff."
The NTMA has so far only confirmed that the new bonds will offer yields "considerably higher" to other euro-zone countries, with Haugh saying that the benefits of such a trend would be felt by employers, who would likely consider standing by a now better funded DB scheme for longer.
However, the sovereign bond and its annuity cannot yet be hailed as the salvation of the Irish pension fund, with many questions asked and few facts known.
"All that remains to be seen is the detail, the extent to which it will get credit within the funding standard. We don't know that yet, the Pensions Board hasn't released it yet," Haugh points out, adding that how exactly the regulator changes the standard is vital for the success or failure of the new issuances. "If it doesn't really substantially change anything, then it won't go anywhere."
The only certainty agreed upon seems to be that there will be change, regardless of the outcome.
"The old model is broken and is unsustainable making change inevitable regardless of political uncertainty," argues Haugh, again emphasising that any change will happen over a shorter timescale than perhaps wise.
Watkins is even more pessimistic on the future facing DB schemes, claiming it is doubtful employers will look only towards the recent changes when deciding to maintain their pension funds as final salary ones.
"It is more likely that employers have just been hit too hard in the recent past to consider anything other than limiting their exposure to DB liabilities. Paternalistic employers may see this as a way to retain their DB scheme but I would envisage the increasing trend of DB schemes closing and new DC schemes opening inevitable."