PENSIONS: Irish employers seem set to follow British trend towards defined-contribution plans; however, employees will have to be consulted on changes, writes Mary Canniffe.

A number of Irish employers are considering changing their company pension schemes from defined-benefit plans to defined-contribution plans, according to industry sources. Greencore is currently discussing a change with its employees.

This move would follow a trend already evident in Britain, where a number of companies - including J Sainsbury, Lloyds TSB, BT Group, ICI and Whitbread - have closed their defined-benefit plans to new members.

Ernst & Young and Iceland have not only closed their defined-benefit schemes to new members but also to any new contributions for existing members - the existing schemes will be frozen and upgraded annually only by inflation.

This trend is being driven by new accounting standard FRS 17, poor investment returns and rising mortality levels among pensioners. The good news for Irish employees is that the Pensions (Amendment) Bill, currently before the Dáil, will require consultation with staff before any changes can be made in their existing pension arrangement.

In defined-benefit or final-salary schemes, employees are promised a pension when they leave service based on final salary and years of service - often two-thirds of salary after 40 years' service. In these schemes the employer, who is committed to paying this level of pension, takes all the risk that the fund will produce the investment performance necessary to meet the required returns.

In defined-contribution schemes, pension payments depend on the investment performance of the fund - the employee takes the risk on investment performance and is not guaranteed any predetermined level of pension. The employee's pension will depend on fund performance and the amount paid into the fund by the employee and the employer.

The essential difference is where the investment risk lies. With the introduction of FRS 17, the risk involved for employers in defined-benefit schemes must be shown clearly in the company accounts.

FRS 17 means companies must compute their pension-fund surpluses or liabilities each year using market values at the balance-sheet date.

Surpluses or deficits must be entered on the company balance sheet, introducing potential for significant volatility as the value of investments rise and fall.

High levels of investment in equities mean greater risk - but also potentially better returns over time, and more potential balance-sheet volatility.

Up to now pension fund surpluses and deficits have been calculated on a long-term smoothed basis - to eliminate the impact of short-term market fluctuations on long-term investments.

While companies will not have to pay cash into the fund to cover short-term pension fund deficits, shortfalls will reduce company reserves, which in turn could affect bank borrowing covenants or their ability to pay dividends. Because markets are volatile and the value of investments rise and fall, FRS 17 has the potential to bring a large degree of volatility to the accounts of a company with a defined-benefit scheme.

Some companies have moved to deal with the volatility by reducing risk. Lower risk means a smoother and more predictable pension fund performance.

In Britain, Boots sold off its equities and invested its fund in Government bonds - market analysts say most funds would be reluctant to do this because it would result in lower investment returns over time. Some companies have reacted by abandoning defined-benefit schemes altogether.

Other options for reducing risk have been suggested, including dividing the fund between two different-style fund managers or diversifying part of the fund into uncorrelated assets to produce more return at lower risk levels.

FRS 17 has been good for some companies - AIB added €39 million to profits in its 2001 accounts because of a surplus of assets over liabilities in its pension funds.

While in recent years new pension schemes have largely been defined-contribution plans, this trend now appears set to accelerate and existing defined-benefit schemes are coming under pressure.

In most cases, the move involves closing existing defined-benefit schemes to new employees and inviting existing employees to switch from their defined-benefit plan to a defined-contribution plan.

There can be advantages to being in a defined-contribution scheme but there are risks that employees need to take into account.

With a defined-benefit scheme an employee knows exactly what their final pension will be, based on length of service and salary at retirement.

With a defined-contribution scheme, the employee's pension depends on the amount put into the fund and the investment performance of the fund that provides the pot of money available at retirement. This could result in a pension of two-thirds of final salary but there is no guarantee.

Another risk in defined-contribution schemes is that employers will contribute less than they would have to contribute to a defined-benefit scheme. Industry experts say the level of employer contribution is considerably lower in defined-contribution schemes.

Defined-contribution schemes are more flexible - employees can contribute 25 per cent of salary to build up their funds.

Generally defined-contribution schemes are often attractive to younger, higher earners. But for most employees defined-benefit scheme offer the security they want from a pension plan.