Ring-fencing DB schemes
One open question in the Irish defined contribution (DC) market is the impact of the Personal Saving Retirement Account (PRSA). PRSA are a contract-based DC pension product. They bear a strong similarity to the UK’s stakeholder pension in that it is to extend pensions provision to people who, so far, are not covered by existing schemes.
As in stakeholder, there is mandatory access to PRSAs. Employers are obliged to provide access to a PRSA if they do not operate an occupational pensions scheme, or when they operate a scheme with various restrictions on eligibility.
Once PRSAs are established, they could provide a boost to the devlopment of DC schemes. There are plans to introduce regulations to provide for the transfer of PRSA assets to both DB and DC schemes.
Conversely, the introduction of PRSAs could provide employers with existing DB or DC schemes with the opportunity to switch to a cheaper and simpler system.
This is something the regulators are anxious to prevent. Philip Dalton, head of the PRSA unit at The Pensions Board says the aim is to increase coverage, not to encourage switching. “We don’t want a substitution effect – that would defeat the purpose of PRSA.”
To prevent substitution, the legislators have built what critics describe as a ‘Berlin wall’ around occupational pension schemes to prevent DB and DC schemes defecting to PRSAs. Transfers from occupational pension schemes to PRSAs are only allowed for employees who have been in an occupational scheme for less than 15 years. Otherwise, employers must place their funds in buy-out bonds (BOBs) and then start up a new PRSA.
There are other hurdles to prevent ‘indiscriminate’ switching. “If somebody comes out of a good DC scheme and switches to go into a PRSA they cannot transfer without a Certificate of Benefits Comparison,” says Dalton. “It’s not just anybody that can give that certificate, and the person preparing it must have personal indemnity insurance cover.”
There may be little incentive for employees to switch. As in UK stakeholder schemes – employers are not obliged to contribute anything to a PRSA. Dalton believes the success of PRSAs will depend on whether employers are prepared to contribute. “The only major difference between being in an employer’s DC scheme and a PRSA is it’s most likely that the employer is contributing, whereas there is no compulsion with a PRSA. That’s a huge difference. If employers start paying into PRSAs they could become quite successful.”
Paul Kenny, head of retirement services at Mercer in Dublin, says that smaller employers are most likely to make the switch from a DC scheme to group PRSAs. “Among small schemes currently on a DC basis, there will certainly be an incentive to employers to wind them up and put the proceeds into buy-out bonds (BOB) if they can’t put them into PRSAs, as the main means of pension provision. Among the biggest schemes I don’t see any huge incentives for employers to move from DC schemes under trust. They enjoy economies of scale that make it considerably cheaper to run than the smaller end of the market.”
A further disincentive to switch is that PRSAs provide for immediate vesting, compared with the two years’ vesting of DC schemes. “Because an employer has to offer membership of a PRSA instantly to everybody – including part-time workers – you’re going to have high turnover within two years, particularly among young people. This means that there are bound to be pretty heavy costs on the employers.”
Higher paid employees will not want to switch from DC schemes into PRSAs because of the earnings cap on PRSA contributions and the limit on the contributions. Total contributions will be capped at 30% including anything the employer is prepared to pay. “In an occupational pension scheme the only limit is the benefit limit. So as long as pensions are within two thirds of total remuneration, there’s really no limit on what can be contributed,” Kenny points out.
There is a growing belief that PRSAs, far from poaching from the DC markets, could underline the advantages of occupational DC plans. PRSAs treat an employer’s contribution as a benefit in kind, for which the employee must claim tax relief. This creates an administrative complexity that is absent in DC schemes.
And because of economies of scale, occupational DC plans are likely to have lower charges than the maximum level allowed under standard PRSAs of 5% of contributions and 1% of assets.