ANALYSIS:Some fear the Minister has evaded the crux of the pensions problem – that the funding standard is broken, writes DOMINIC COYLE
YESTERDAY, THE bulk of final salary pension schemes were in trouble; today they are in turmoil. The intervention of Éamon Ó Cuív has succeeded only in fuelling uncertainty.
The Minister for Social Protection told the Irish Association of Pension Funds’ Benefits Conference that the Government will “expedite the proposal to move to a ‘new’ defined-benefit model” in an effort to address the strains in the industry.
The problem is he gave no detail. And it became clear as the day wore on that no detail has yet been worked out. The Minister’s template is an outline of a possible new pension structure that was included in the National Pensions Framework published last March.
A cross-party implementation group is working on the framework, which was supposed to be phased in over the next four or five years. However, as yet, it has not fleshed out the proposal that the Minister now wants to expedite by July 1st next year.
The approach outlined by the Minister would see pension fund members receive “promised core benefits”. In addition, there would be “flexible benefits” payable when investment performance allowed.
For employers, the benefit would be clarity on the cost of providing pension benefits; the contributions of both employers and members would be fixed. The National Pensions Framework argued that such a scheme would also give members “a clearer understanding of the benefits that their scheme will provide and gives them a clearer basis for retirement planning”.
Any such approach would require legislation that could only be formulated after extensive consultation, which has not yet begun.
A survey presented at the conference said over 70 per cent of defined-benefit pension schemes – where the fund promises to pay a certain proportion of working income in retirement rising in line with the number of years served – fail to meet the Minimum Funding Standard (MFS).
The standard, set by the regulator, lays down the minimum level of assets that a defined-benefit scheme must hold to meet its obligations to members. While most of those obligations relate to people still in employment, some of whom will not retire for many years, the MFS states that a fund must hold sufficient assets to buy an annuity today to meet the accrued benefits of members in the event of the scheme being wound up.
In assessing the cost of that annuity, they must use the yield on long-term German bonds. However, the historically low yield of such bonds is ratcheting up the cost and creating a hole in the pension funds of companies across the State.
Schemes with a funding shortfall are obliged to agree a plan with the regulator to address the problem either by increasing contributions, adjusting investment strategy or, in extremes, cutting benefits already accrued by working members and even future increases for members in retirement.
The deadline for such plans was set at November 30th. As part of his proposal yesterday to expedite a new approach to pensions, the Minister deferred this deadline to a date unknown in the future. However, any new deadline would have to be set for a date after the introduction of the new scheme and allow a period for proposals to be drawn up in the context of the new arrangements.
That means a new deadline for schemes to put their house in order could be a year or more away. Failure to do so runs the risk of schemes, and their sponsoring companies, becoming insolvent and being wound up.
Pensions adviser Ray McKenna, managing consultant at Towers Watson, says the Minister has simply evaded the central problem, “which is that the funding standard is broken”.
One measure that might, in part, address this is to allow pension funds to reference their liabilities not solely to German bond markets but also to higher yielding debt such as that of Ireland. As of yesterday, German bunds were yielding 2.3 per cent; their Irish equivalent was offering a return of 6.4 per cent.
The Irish Association of Pension Funds and the Society of Actuaries has lobbied actively over the summer for the Government to allow this sovereign annuity arrangement. The Minister said yesterday that the proposal was receiving “thorough consideration” but he was not able to say as yet whether it would be accepted.
Other industry figures are more generous in their assessment of the Minister’s position. The current historic low in bond yields means that troubled pension schemes are having to make substantial reforms, even reducing benefits already accrued by staff, at the very worst point in the cycle.
Granting underfunded schemes time to organise restructuring, they argue, will hopefully see them doing so in a less hostile bond market which, in itself, would solve a significant part of the problem.
“Even if we only get halfway to a solution by next July,” said one senior industry source who was deeply sceptical of the timeframe set out by the Minister, “we will be light years ahead of the rest of Europe.”
For his part, the Minister is clear that his proposal represents a “least worst option” for schemes that are so underfunded that they would not have been in a position to meet the end of November deadline for restructuring proposals.
He cautioned that the measures should not be seen as a “silver bullet” but were a concerted effort to provide a halfway house for schemes that would otherwise be forced to move entirely to the defined contribution model where retirement income is set entirely by the investment return of contributions.
“Pension schemes still have to address their liabilities, their risks and their investment strategies in order to ensure that they are properly funded and we expect them to do that,” he told his audience yesterday.
The problem for Ó Cuív is that the Government has a long history of promising reform of pensions without substantial delivery. Measures to address pension coverage and adequacy were first unveiled with the National Pensions Policy Initiative in 1998.
In 2005, then minister Séamus Brennan ordered a statutory review ahead of schedule when it was clear those targets were not being met.
A succession of ministers have now produced reviews, Green Papers and, earlier this year, the National Pensions Framework. But even the first major element of that last document – legislation to allow holders of defined contribution schemes have more control of their funds in retirement rather than having to buy an annuity – which needs to be in place by the end of the year, is still awaited.
The industry and those who rely on it for their financial security in retirement will hope that the Minister’s latest efforts will ultimately provide some certainty.