The main challenge facing Irish pension funds with defined benefit (DB) type plans over the past 12 months has been meeting the minimum funding standard.
The Pensions Acts set out a minimum funding standard for DB schemes generally. This is a wind-up standard, based on the benefits a scheme is obliged to provide should the scheme be wound up.
The funding standard defines the minimum assets that each scheme must hold, and sets out the rules that apply if a scheme falls short. Under the general rules, schemes that did not meet the standard have to restore full funding within three years.
When the present standard was introduced most schemes were in surplus and had no difficulty meeting the standard. This is no longer the case. Partly as a result of the investment losses that DB pension schemes experienced in the three year equity bear market that began in 2000 many of the 1,541 DB schemes subject to the funding standard cannot meet the standard. According to the Pensions Board the proportion of schemes satisfying the funding standard in 2004 fell sharply compared with 2003. It estimates that currently 40% to 50% of schemes are failing to meet the standard.
More than half of the schemes that did not meet the standard plan to restore funding within three years, mostly by raising contributions. However, raising contributions has led to a situation where the long term objectives of the pension fund have come into conflict with the short term objective of restoring funding levels.
Gerry Ryan, chairman of the Irish Association of Pension Funds (IAPF) and the group secretary of the two Eircom pension plans, says: “The problem associated with setting a short time frame for funding deficits in some pension schemes is that sponsoring employers may be fully committed to maintaining the pension benefits proposed for employees but unable to increase contributions to the levels necessitated by short term funding requirements.”
Over the long term, the effect of the funding standard has been to discourage employers from setting up new DB schemes. Although the number of active members of DB schemes subject to the funding standard has increased by 21% from 189,948 at the end of 1991 to 230,685 at the end of 2003, the number of schemes has fallen from 2,514 to 1,541. The decline has been greatest among schemes with fewer than 50 members, where numbers have halved.
The Pensions Board is now reviewing whether changes should be made to the funding standard. As an interim measure it has relaxed some of its requirements. Schemes that do not meet the standard wholly or mainly because of investment losses can apply to the board for an extended period to restore full funding. The maximum extension is normally 10 years although the board will consider longer extensions in exceptional circumstances.
The board says that employers will still be required to fund their pension schemes prudently and that trustees will be obliged to keep members informed of solvency issues.
Looking forward, Ryan says the investment climate has improved, if somewhat patchily. “Obviously it’s been a difficult for pension funds since 2000, and at least we got back to positive territory in 2003. In 2004 the first half has been like the curate’s egg. It hasn’t been consistently good or consistently bad. There is a still a lot of uncertainty in the market about the direction we should be going in.”
The problem of greater longevity is also pressing down on pension funds, he says. “Ireland has the same issues as anywhere else in relation to the growth in liabilities. People are living longer and so pension funds are certainly looking at the liabilities side of the equation a lot more closely.”
Similarly, the impact of international accounting standards is making itself felt. “Companies are focusing on the impact of DB plans on their overall financial position because of the new standards. There’s been a lot more focus on this than there was two or three years ago.”
Uncertain markets are encouraging pension funds to adopt new approaches to their investment strategies, he says. “Irish pension funds are becoming more interested in more sophisticated arrangements, with the growing use of specialists. There’s a lot of interest in Ireland in trying to see if alternative investments like private equity can fit into pension fund portfolios. Overseas property as well is becoming of increasing interest to Irish pension funds who are often looking closely at the market in the UK.”
Funds of hedge funds are also a possible option, although only for the future, Ryan says. “The Eircom funds are looking at them and exploring the options but we’re a long way to getting to a decision on that. One of problems about investing in funds of hedge funds is that the due diligence requirements are quite significant. So at the moment we’re building up our knowledge base by talking to providers and consultants and the fund of hedge fund managers themselves.”
Overall, the Eircom pension funds’ approach is to keep a steady hand on the tiller, he says. “We haven’t made any decision relation to a major change in the investment policy. We very much recognise it’s a long term business and we shouldn’t be jumping this way or that just because of changes in the market.”