Which way to go?
The government’s Green Paper is focusing attention on the options to develop Ireland’s pensions sector. Nina Röhrbein reviews them
The Irish government is expected to decide the future pensions framework next year, based on responses to its recently released Green Paper on Pensions.
The Green Paper sets out the challenges faced by the Irish pensions industry - in particular an improvement to the 2005 pensions coverage rate of 55% and adequacy - and the options available.
In an attempt to increase coverage, the government introduced personal retirement savings account (PRSA) in 2003 as a low-cost, flexible, user-friendly pension product. However, it has not had much of an impact on the coverage rate. Still around half of the workforce has no pension provision other than the state social welfare pension.
So among the options to be considered in the current round of consultations following the release of the Green Paper is making participation in a second pillar scheme mandatory.
Patrick Ferguson, CEO and pension fund secretary at the Construction Workers Pension Scheme of Ireland (CWPS), the country’s only large industry-wide scheme, can see the merits of a mandatory scheme but believes it would provoke a wave of protests. “The fact is with a mandatory scheme you would get objections from members asking why should they have to do that,” he says. “And that is fine until they come to retirement and then complain that employers did not put them into a scheme. So employees and workers need a little kind of push from behind to get them to join a scheme.”
“Employers are unlikely to support a mandatory scheme because they regard it as an additional cost and an administration headache,” says David Harney, chief executive of corporate business at Irish Life. “But if you cannot figure out a way to fund a better first pillar or create a more attractive voluntary pillar, then mandatory is the only option.”
However, Paul Victory, a consultant at Watson Wyatt in Dublin, believes that many lower-paid workers who are struggling to make ends meet would not welcome being obliged to put money into a mandatory pension scheme. “Freedom of choice is a key issue with mandatory pensions,” he says.
“And there is a danger that adequacy could be sacrificed for coverage because in a mandatory scheme, the initial required level of contributions would have to be kept fairly moderate, which means many workers could end up with less generous benefits than in the current voluntary system. And it would certainly be another blow to DB schemes. On top of that, any move which increases employment costs could adversely affect Ireland’s ability to attract inward investment.”
Marie Daly, head of legal and regulatory affairs at the Irish Business and Employers’ Confederation (IBEC) and a member of the regulator, the Irish Pensions Board, which also advises the government, says that mandatory pensions are unpopular with employers who want flexibility in their employment policies. “Most employers believe that the existing, voluntary system works well,” she says.
“If the government introduced mand-atory pensions, less profitable and labour-intensive companies in sectors like manufacturing would be hit with the bigger bill, which could make them more uncompetitive,” Daly continues. ” And force often produces counter-force, which results in non-compliance. Although some employers, usually those already offering pensions, see a merit in a soft-mandatory system - where employers are required to auto-enrol people into pension arrangements but employees can then opt out - businesses generally regard this merely as a stepping-stone to hard mandatory. This makes the business community reluctant to buy into such a radical departure from a system, which, although in need of improvement, generally works well here.”
But Ferguson believes that an initiative like the soft-mandatory approach is needed to get employees to adopt pension schemes. “We are the example that industry-wide pension schemes can work in Ireland,” he says.
“Admittedly, we have had the advantage of the Registered Employment Agreement between employers and trade unions in the construction industry. This statutory agreement, combined with the scheme’s transparency and the fact that we are able to buy annuities from our own in-house annuity fund at a 10% discount to the market, has helped us to achieve our coverage rate of 85%.
“Despite some non-participation issues, we will propose that industry-wide pension schemes run by the industry are the way forward, in particular as they serve the needs of a highly mobile workforce. In most industries, the representative body knows what the industry needs and can afford and how best to promote the scheme within the industry.”
But he cautions that the success of industry-wide pension schemes also depends on the size of the industry and workforce.
Ferguson attributes the remaining 15% of the industry that has not joined his scheme to employees of very small, mobile firms who are difficult to contact. But he says the CWPS will launch a promotion campaign later in the year to further increase its participation rate.
However, Harney believes Ireland’s workforce is too fragmented for more industry-wide schemes, while industry sectors with strong unions tend to have reasonably good coverage rates anyway.
The Irish Association of Pension Funds (IAPF) will look closely at the potential for industry-wide schemes in sectors with traditionally low wages, low pensions coverage and high mobility such as hospitality and catering, according to Jerry Moriarty, IAPF’s director of policy.
But Michael Leahy, chief executive of Standard Life in Ireland and chairman of the €55m local Standard Life DB plan, says in a mature market like Ireland, where different benefit structures have built up over time in existing schemes, it would be difficult bringing these benefits into line with each other as part of a move to industry-wide pension schemes.
According to Victory, industry-wide pension schemes generally work best when they are based on collective bargaining and social partnership agreements negotiated between employers and strong unions. “The advantages of industry-wide pension schemes are the big savings due to economies of scale and facilitation of employee mobility,” he says. “The disadvantages could be difficulties in ensuring everyone’s participation and the moral hazard in terms of salary manipulation.”
In addition, pension participation levels in Ireland have been kept lower than they might otherwise have been in recent years by two contributory factors, Victory adds. “One factor is the amount of net inward immigration, because pensions are often not a high priority for immigrant workers. The second reason is the introduction of the Special Saving Incentive Accounts (SSIA).”
The SSIAs - designed to encourage more savings and slow the dramatic growth of the economy - ran over a five-year period starting between May 2001 and April 2002. Individuals could put up to €254 a month into a savings contract, and for each €4 saved, the government added a further €1 in lieu of tax relief on contributions but benefits could be drawn down tax free, which financially would be the same as tax relief at 20%, the current standard rate of income tax, according to Stephen Lalor at consultancy Coyle Hamilton Willis.
“As a result of this flexible, tax-effective deal, a lot of savings that might have otherwise gone into pensions went into SSIAs,” says Victory. “The five-year maturity allowed people to see the money coming back within a reasonable timeframe. One of the issues with pensions is that money is locked away for such a long time.”
“There have been suggestions for access to some of the money at earlier stages in a long-term SSIA pensions regime, which would then reduce your tax-free cash entitlement at retirement,” says Moriarty. “The concept is good and if you get a lot of people on board, like the employers and trade unions, it certainly has a future.”
“The biggest challenge for DC business is the adequacy of pensions,” says Harney. “With almost €5bn invested in DC schemes the average contribution rate is currently around 12% [of a gross salary] but we are trying to push this up to 16%. Our proposals will focus on how to make DC more attractive and simplify the tax regime. We believe that a pension regime like the SSIA would be understood more easily.”
“One possible disadvantage of such a system is that it could add yet another layer of complexity alongside the existing system,” says Moriarty. “That is why more research needs to be done on how it would work in practice.”
“SSIA-style pensions have a lot of support from those who favour voluntary rather than compulsory arrangements,” notes Brendan Kennedy, chief executive at the Pensions Board, the Irish Regulator, which is an adviser to the government. “But as we have only had five-year SSIAs there is no guarantee that such a system would work as well for pensions.”
“Although pensions tax relief is usually better, SSIAs have been much simpler and therefore been able to overcome the pensions fatigue factor,” says Daly. “Ireland has a strong savings culture - as evidenced by the SSIAs - so I suggest building on that. However, it is unlikely that the government would commit itself to contributions for 25-plus years; they are more likely to be attracted to plans for three to four years to kick start the system.”
“The new minister for social and family affairs, Martin Cullen, has indicated he will consider a SSIA-type pension product,” says Harney. “Experience with the approved retirement funds - the ARFs where pension holders are allowed to invest in a managed fund rather than having to buy annuity at retirement - has shown that even when people have early access to the money, they are slow to draw it down, in particular if there is a penalty on an early drawdown.”
Kennedy believes that PRSAs have a part to play within a system of mixed incentives and encouragement.
But for Ferguson, the problem with PRSAs is that employers only have to introduce a provider to their employees, they are not required to ensure their workforce participates in one nor do they need to make any contribution.
“If you are working for a small firm or are self-employed why would you want to go into a PRSA when you think you cannot afford it?” Ferguson asks. “That is why there is a lack of enthusiasm for PRSAs despite their attractiveness, and their uptake has not been great.”
Harney disagrees: “As a product of their own, PRSAs have been very successful if you look at the number of PRSAs that have been taken out in the five years of their existence. When people say PRSAs have not been successful they are judging them against an unrealistic target. In the future, PRSAs should be simplified as they currently require a detailed fact find on the person wanting to take it out and require more paperwork than any other pension product.”
Victory notes that growth of PRSAs over the last few years has been steady rather than spectacular, with around 120,000 people currently in possession of a PRSA, giving a total value of around €1.12bn. “Maybe one of the ways to improve the take-up is to find some way of incentivising employers to encourage participation in PRSAs,” he says.