Some years back the Bank of Ireland set itself the challenge of creating a new pension scheme providing a more homogenous investment approach for employees across the whole group. Nina Röhrbein spoke to the bank's head of pensions, Michelle Roche, to learn more about this young scheme's progress
Bank of Ireland's LifeBalance pension scheme was established some two years ago, replacing the previous defined benefit (DB) scheme, which had €3.5bn in assets at the end of 2007. There is also a smaller UK LifeBalance scheme for Bank of Ireland staff based in the UK.
As Michelle Roche, head of group pensions at Bank of Ireland, explains: "Each of our subsidiaries used to have their own individual schemes with various terms and conditions, contribution rates and retirement ages.
"One of the biggest drivers behind the new scheme was to try to harmonise the pension benefits that all of our employees receive and have one standard across the group. This facilitates people moving between companies or between jurisdictions within the group. However, the two schemes still needed to comply with the individual membership and taxation rules in their respective jurisdictions."
LifeBalance is a hybrid cash balance arrangement with elements of both DB - called the Retirement Capital Account (RCA) or core credit account - and defined contribution (DC). It is not a traditional DB scheme, which guarantees the pension benefit; rather the DB element builds up a fund at retirement with the member knowing how much is being set aside for them in that fund. At retirement, the assets are used to buy an annuity or a pension. The DC element is a top-up account - called Personal Investment Account (PIA) - that runs alongside the core credit account. Members can contribute additional amounts to this top-up account voluntarily, with the employer matching contributions for the first 3% paid into that account.
In terms of benefits, the RCA provides for a 20% credit, which is applied to an employee's base salary each year without being offset against state pension provision. The credit is revalued annually in line with inflation of up to 4% and a discretionary investment credit, which seeks to deliver an extra 2% each year.
In the Irish LifeBalance scheme, all new employees are automatically enrolled in the RCA scheme, while employees in the UK scheme can opt out, in line with UK legislation. But, according to Roche, the large majority of members actually stay in the scheme once they are enrolled.
"In the UK scheme we see that the percentage of people remaining with the scheme is actually much higher than it was in the old DB scheme," says Roche. "We, like many Irish businesses that closed their old DB schemes, moved to a hybrid rather than a DC scheme because we believe it offers a better balance of risk and reward for the employer and the scheme member."
LifeBalance members can choose and switch between five different investment funds in their PIA: an all-equity fund, a pension managed fund with 75% percentage in equities and elements of fixed interest and cash, a consensus fund, a long bond fund and a cash fund. Various fee structures are attached to them, with the all-equity and pension managed funds being the most expensive and consensus fund being the least expensive.
But according to Roche, with the new entrants to the scheme being relatively young - at an average age of 26 - not every member has taken up the top-up account option at this stage. However, she says of those who have, most have gone for the managed fund option so far while the all-equity fund has been the most popular with the asset management and global market staff of the Bank of Ireland.
"I also expect life-style related investment options to be introduced in time, which will change with the member's age. But due to the scheme being so young and with some time until the first pensioner retires, it is not a necessity for now," says Roche.
At this early stage in the scheme's life, asset allocation plans have not been finalised. "When we started out initially we put all of the assets into interest-bearing deposit accounts because for the first few months the cash flows were very low," says Roche.
"We have only just started to move them into equity-based investments. And maybe it would have been better to leave them in the fixed-interest deposit accounts for longer because those have done better in the recent past. Because our assets under management currently only amount to €12.7m and we need to grow to a reasonable size before we can actually start allocating to different asset classes, we have not decided yet about our exposure to alternatives such as private equity or hedge funds," Roche admits.
"But the advice from our scheme actuary is that we should be nearly 100% invested in equities for the next three years. However, we will probably continue to have some exposure to cash-related or fixed interest investments for cashflow purposes as we still need access to some of the fund's money in the short term to pay benefits and administration costs."
LifeBalance had its first high level investment review after 12 months in order to design a more active investment strategy. Roche expects assets to grow considerably over the next few years, as new members join the group. "The scheme will probably be five years old before we do a full investment allocation," she says. "But our first full actuarial valuation is due this autumn."
According to Roche, LifeBalance will ultimately - when it has reached a large enough size - adopt a similar investment strategy to that of the old DB scheme. That has specific benchmark returns for each asset classes, based on a number of composite index returns appropriate to the particular investment distribution for each asset class.
"But the overall investment strategy in the short term will be different in that we will have a higher weighting in equity-related investments due to the younger population of the new scheme," says Roche. "Currently active equity investment is just below 40% of the total asset allocation of the old DB scheme. This is down from over 60% in 2006 and is split between Irish, eurozone and global ex-eurozone market equities.
"But we also have around 17.5% invested in passive equities, such as the State Street indexed fund. On top of that, we are going to have around 10% allocated to alternative investments like hedge funds and private equity, while the remainder is property, cash and fixed interest based investments."
"The bite-size investments that you need for exposure to hedge funds or private equity tend to be of the €20m and above magnitude. This means that we need to get up to the €100m level of total assets under management within the new scheme before we can be at an efficient size to contemplate such alternative investments. Alternatives are also quite new to the old scheme - we have only recently started investing in this category - and so we will watch what they will bring to the DB scheme."
Due to its early inception, the credit crunch has so far failed to have a major impact on the LifeBalance scheme. "However, it has severely affected the old DB scheme where we have seen a significant decline in our asset values over the past 12 months. In particular our equities and property portfolios returns have been quite poor with negative returns of over 12% and 5% respectively.
"Liability values have only fallen slightly so we have to monitor the situation closely, although no additional funding or increase in contribution rates is currently required. We are currently in the middle of restructuring the investment portfolio of the old DB scheme and are in the process of making the 10% opportunistic allocation to alternatives for extra diversification, which will come out of our active equity management."
Roche says while the risk associated with increasing pensions in payment is not an issue for the new hybrid scheme, inflation risk is still present, albeit to a smaller extent than with DB schemes. "There obviously still is an inflationary risk in the LifeBalance scheme," she says.
"And in the short term there is no buffer between its assets and liabilities, meaning that changes in the market can heavily impact on the scheme. That is why we have to keep a close eye on the scheme to make sure we are funded adequately at all times, until we build up a sufficient buffer or a surplus, which allows us to take a more active investment strategy without risking a dip below the liability level. We will also have to look at the impact of accounting standard IAS19 and the ongoing actuarial valuation, not just the minimum funding standard valuation.
"For the smaller closed DB schemes, ageing membership means that their investment strategies will need to move to a more fixed interest or bond-based strategy if the funds are not pooled with an open fund in the future. So the introduction of a new scheme does not just bring challenges in its own right, it is more about the impact it has on legacy scheme schemes."
Liability driven investment (LDI) is less important for the new scheme at the moment. "For the old DB scheme it is important due to the general inflation risk associated with the scheme. We conduct various reviews of the value at risk in our DB schemes to try to match the investment strategy with the liabilities coming to maturity. The new scheme protects in some way against inflation risk and because 20% of employees' salary is notionally allocated into the core credit account each year, it means the liabilities are known in the year that they happen."
Because the majority of LifeBalance's assets were placed in deposit accounts initially, the asset manager selection process for the Irish scheme has not been completed. For the UK scheme this process has already taken place because the new scheme there merged with the two already existing UK schemes, resulting in a much larger combined asset value and immediate equity management requirements.
"We will look at a number of different options and ask each of the asset managers to make a presentation to the trustees, who will then make a decision based on the presentation with the help of our advisers," Roche says.