Momentum for change gathers pace
The development of defined contribution (DC) pension plans in Ireland shows many similarities with the current situation in the UK, with companies switching from defined benefit (DB) to DC plans to remove pension fund risk from their balance sheets.
Certainly the pressure on companies in Ireland to close off DB plans to new entrants and introduce DC plans in their place is likely to increase with the threat of new accounting rules and the persistence of weak equity markets.
However, there are significant differences in the pace and scale of the move to DC in Ireland, largely due to the structure of the labour market. A large public sector, and strong union support for DB schemes will ensure that much of the pensions landscape remains unchanged for some time.
Among existing schemes, DB is still the dominant type of pension plan, particularly among larger companies. Seven out of 10 of the largest pension schemes in Ireland are DB. Yet among new schemes the trend to DC is unmistakable. Some 99% of all new schemes are DC. The Pensions Board figures for 2001 show a net decrease of 71 in the number of registered DB schemes. Meanwhile, the number of DC schemes increased by 11,654. The board estimates that 44% of private sector pension plans are now DC.
In terms of membership, the DB:DC ratio has been decreasing to the point where it is almost one to one, with 214,871 active members of DC schemes compared with 229,011 members of DB schemes.
The move has not been across the board, however. Particular types of employer have opted for DC. These tend to be the ‘new economy’ IT companies such as Intel, Amdahl, and Novell; the banks and other financial institutions, such as Davy Stockbrokers, Anglo Irish Bank, and AXA Ireland, and multinationals, such as IBM, Volvo and GE Capital/Woodchester.
Patrick Burke, chairman of the benefits committee of the Irish Association of Pension Funds (IAPF) a director of Irish Pensions Trust, says that firms with a mobile workforce have proved to be more likely to take the DC route. “Where DC plans are most prevalent is ‘newer’ industries to Ireland – frequently Irish operations of US-based multinationals – with highly mobile employees, who will take their benefits with them. In a DB arrangement, young leavers and those leaving after a period of short service would, historically, not have taken a significant transfer value. So, assuming similar contribution rates, there was a greater generosity to mobile members leaving DC schemes than there had been previously.”
However, the number of medium sized and large companies moving to DC has been smaller than expected, he says. The IAPF benefits survey 2002, published in June, showed that the rate of closure of defined benefit schemes, across all the companies surveyed, has been about 7% over three years.
There is also evidence that it is chiefly the smaller companies that are putting DC plans in place, he says. Of the DC schemes, 79% had fewer than 250 employees and 58% had fewer than 100.
However, this situation may be changing. The ‘old economy’ foods group Greencore which employs about 3,000 people in Ireland is planning to close its DB plan to new entrants and establish a DC plan.
Paul Kenny, head of retirement services at Mercer in Dublin, agrees that large companies are showing more interest in DC. “The landscape is changing to the extent you are seeing small but significant increases in the numbers of quite sizeable DC schemes. A few years ago you wouldn’t have found one DC scheme with more than 1,000 members. Now they’re in double figures.”
One brake on the move to DC by large companies is the strong union backing for existing DB schemes. Nora Finn, chief executive of IAPF, says this should not be underestimated. “The social partnership has worked very well in Ireland. There are problems coming through now with the pressure companies are under, but it has been very successful and it is likely to continue. Certainly there is a lot of government pressure to maintain it.”
Another brake on development is the existence of a surplus in a company pension scheme. Joe Byrne, deputy managing director of pension consultants Coyle Hamilton, says that employers in Ireland have little incentive to switch to DC so long as a surplus remains in their pension plan: “The surplus situation is very different in the UK, where if you wind up a scheme, benefits have to be improved up to a certain level before the surplus is returned to the employer. Whereas in Ireland you can give people their benefit entitlements, but if there’s any money over, some pensions schemes would allow that to return to the employer” he says.
“If you’re going to switch to DC your employees will look for all this money to be applied to them. Companies with particularly well funded plans wouldn’t necessarily be happy with that, because if their employees leave subsequently, they will leave with a share of the surplus. So they are unlikely to switch if they think they are going to lose control over a certain amount of their capital.”
Byrne suggests that companies that do switch to DC tend to be the ones with under-funded schemes, who have little or nothing to lose by the move.
A longer term problem for DC plans is whether they will be able to deliver the two thirds of final salary that the best DB schemes have after 40 years with a company. Broadly speaking, average contribution levels are far too low to deliver this.
The IAPF benefits survey found that average employee contribution was 4.6%, and the average employer contribution for schemes of over 50 people was 5.9 % providing a total contribution of 10.5%, in many cases inclusive of death in service benefits.
Burke says the danger of these averages is that they can provide employers with an inadequate contribution benchmark for new DC schemes. “The fact that the average has been trending ‘five and five’ is a great problem, particularly for higher paid workers, because in many cases there is a real risk that employers will seek to determine the average contribution rate paid by other employers competing in the same labour market without regard to adequacy considerations. It is very easy to review the IAPF benefits survey and see what the average is, however, it takes a greater effort on the part of employers and members to determine what rates are appropriate to meet the members pension objectives.”
Shifting the risk to the member from the company will also present new challenges to asset managers. Gavin Caldwell, chief executive of KBC Asset Management in Dublin, says there will be demand for greater investment choice and better levels of fund administration.
“Pension fund managers have to be able to offer a lot more choice. The board of trustees responsible for DC schemes are very conscious that they are responsible to individuals, who now own the money, rather than the company. So, instead of a board of trustees making decisions on behalf of their company, they are making decisions as to who is the best asset manager on behalf of hundreds or even thousands of people.”
The other challenge will be the education of pension fund members, he says. “In a DC you’ve got to go through an education process with the members because it’s the members that are taking the box now. If you were a manager in a DB scheme you could get large lump sum cash flow figures. Now you have to get your message across because you’re probably only getting a fraction of the cash flow from a DC scheme that you would have got from a DB one. Your whole servicing level has got to go up a notch.”