The Economic Crisis and Pension Plans- Ireland Ireland's small open economy is working out how to cope with the rapid economic downturn. Pension schemes are similarly affected. The performance statistics for managed funds in Ireland during the two years ended 31st March 2009 post a return of -46.1%. These funds are broadly invested and reflect global trends.
Pension schemes must be operated in conformity with the Pensions Directive which was implemented on 23 September 2005. The previous Irish regulatory regime required minimal nips and tucks to comply with this Directive.
So what has Ireland being doing which is of relevance to the turmoil that markets have created for our pension schemes?
Given that sponsoring employers and employees have neither the appetite nor finances to inject further cash to support pension funds it is not surprising that a "wait and see" approach appears to have been generally adopted by the Irish government as regards what pension schemes ought to be doing to redress the "hole" in pension scheme funding. That said, there have been a few specific developments.
Corporate Governance Improvement
From 1 November 2008 the administration of each pension plan must be carried out by a registered administrator. This has been seen as a generally helpful development as far as pension plan trustees are concerned. The burden of plan regulatory compliance is now spread between a pension professional and trustees who are usually unpaid.
Registered administrators provide various services to the scheme known as "core administration functions". The "core administration functions" are the preparation of annual reports and annual benefit statements for the trustees and the maintenance of sufficient and accurate records of members and their entitlements to discharge the above functions. Failure on the part of registered administrators to carry out statutory duties is an offence.
It is anticipated that a better level of pension plan corporate governance will arise in consequence of this new regime. Trustees will have more time to focus on investment issues rather than on administration and compliance with disclosure obligations.
Defined Benefit Plans
In Ireland, like elsewhere, the cost of defined benefit provision has increased greatly in recent years, with the result that the benefits being promised under current model are becoming unaffordable for most employers.
Employers who sponsor defined benefit pension plans are not required to guarantee their benefits. They are, subject to the terms of a plan's governing instrument, free to wind the plan up at any time without being required to pay whatever shortfall is necessary to secure the full cost of annuities and deferred annuities.
The benefits secured for members will then depend on the value of the assets in the fund at the time of wind up and the member's rights of priority at that time. At present additional voluntary contributions paid by each member are a first priority, followed by pensions for those who have retired (and those who have reached normal pension age without having drawn down pension); active and deferred members entitlements come an equal last.
Currently there is some debate about the fairness of pensioners potentially "scooping the pot". It can leave many who have spent all their working careers being left with little or no pension while those who have just retired enjoy a full pension which might even be indexed at, for example, 3% per annum.
Every defined benefit pension plan (excluding some public sector schemes) must prepare and submit to the regulator (the Pensions Board) an actuarial funding certificate at 3 yearly intervals. Its purpose is to enable the plan actuary to certify whether or not if the plan were wound up at the date of certificate its assets would have been sufficient to meet its liabilities. It is estimated that 90% of defined benefit plans do not currently meet the funding standard.
Where a plan does not meet the funding standard a funding proposal must be sent to the Pensions Board. The proposal must be designed to put the plan's funding back on track within a permitted period.
When the legislation was first introduced in 1990 this was a three year period. During this period additional funding had to be paid in to the plan so that at the end of three years it would meet the funding standard.
Since markets continued to dip many trustees have found that in spite of all best endeavours the proposal went off track. Where this occurs a further funding proposal requiring more deliberations may be necessary. Recent changes to the regime enable the modification of an existing proposal to extend its term rather than having to write a new proposal.
In addition to a three year formal valuation the plan actuary must also give an annual inter-valuation certificate indicating that the plan would meet the funding standard. If this is not possible, depending on the circumstances, a funding proposal may also be required.
Experience has shown that a three year recovery period was in many cases, and for various reasons, too short a period.
It is now possible to apply to the Pensions Board for a longer recovery period than 3 years. In many cases this time extension enables the plan to continue rather than be wound up due to the inability to pay enough into the fund to enable it meet the funding standard within the 3 year period.
The longer period may also give plan sponsors and their trustees enough time for markets to improve and with them the financial health of many defined benefit pension plans.
The Pensions Board reviews in detail all proposed recovery plans.
It has a key role to ensure that pension plans are prudently supervised and it takes this most seriously. It will meet plan trustees and their sponsors to agree, where possible, that appropriate procedures are in place to enable the financial equilibrium of a plan to recover over a period which is affordable to the employer and its workforce.
It is clear that the Pensions Board is mindful of the need to adequately operate the Pensions Directive whilst also appreciating that pension schemes in Ireland are, and continue to be, voluntary arrangements sponsored by employers.
Recovery periods of up to ten years were first introduced a few years ago. Periods in excess of ten years are now permissible in appropriate circumstances. New guidelines were published in February which set out the approach that the Pensions Board adopts in deciding whether to grant applications for extended funding periods.
Trustees are expected to say why the plan does not meet the funding standard and that a recovery period of more than 3 years is not contrary to the interests of plan members. Members must be notified of the plan's funding position were it to be wound up. The proposed contribution rate must be at least equal to the contribution rate if the plan were to continue and may not be weighted disproportionately to the end of the recovery period.
When granting any recovery period of more than 3 years the Pensions Board will carefully scrutinise the reasons why the deficit arose. Some reasons, such as salary increases which were reasonably foreseeable at the previous valuation date, will not be likely to enable an extension of the 3 year rule.
When considering whether a recovery period of more than 10 years is permissible the Pensions Board will consider the existence, quality and enforceability of any employer funding guarantee, the plan's investment strategy and the likelihood of exposure to investment risk during the proposed recovery period amongst other matters.
The Pensions Board will take into account the maturity of a plan. Any extended recovery period is unlikely to exceed the average future working life of active members.
A funding proposal must be agreed and signed by the plan actuary, the sponsoring employer and the scheme trustees. Getting agreement can involve protracted negotiations.
If a plan does not submit a proposal the Pensions Board would have to step in and exercise its statutory power to reduce members' benefits. It has not needed to do so to date and would not wish to.
Time was when the only method of enabling a plan with a deficit to get back on track was for the employer to inject more cash at agreed intervals into the plan.
Plan sponsors have become more reluctant to do this and increasingly are looking at other ways such as the use of contingent assets, parent company guarantees and getting the active members to also contribute or pay more into the plan. Additionally, in some cases scheme benefits are being cut or eliminated for future accrual of benefits.
The Irish Association of Pensions Funds (IAPF) and the Society of Actuaries in Ireland recently proposed a package of measures to Government which address the long-term issue of sustainability of defined benefit schemes as well as the more immediate impact of insolvent wind-ups.
They propose that a mechanism ought to be established that will allow trustees to change the benefits of active and deferred members where the sponsoring employer and the members agree this is necessary for the survival of the plan or have agreed to be bound by the findings of an arbitration body. They argue that facilitating reductions in benefit may in some circumstances be better than driving plans towards wind up.
They also propose that some type of "debt on employer" legislation be introduced in Ireland to prevent solvent employers from reneging on pension commitments. Should this be regarded by Government as too onerous it is suggested that a reduced degree of protection ought to be introduced.
Their third suggestion focuses on the pensioner priority on a plan's insolvent wind up. They suggest that where a pension plan is insolvent it is unfair if pensioners' benefits are fully secured at the expense of other members. They do not propose a solution but the inference is that a more equitable distribution is appropriate between all classes of members.
Where the employer is insolvent they recommend that the State would provide annuities on a "not for profit basis". This envisages that the cost to the State will be less than buying an annuity on the open market.
No formal response has been published to this industry suggestion.
Defined Contribution Plans
In December 2008 the Minister for Finance announced that members of defined contribution plans who retire may defer purchasing an annuity for a period of up to two years. This concession will expire on 31 December 2010. The purpose of the deferral window is to hopefully enable the value of the individual's investment account recover to some extent. The Pensions Board's website suggests that the risks of the deferral be drawn to the individual's attention and that a consent form be signed by the member and the plan's trustees.
Pensions Green Paper
In October 2007 the Government published a green paper on the future of pensions and how best this can be addressed for Ireland. A long consultation period followed. To date no formal proposals have issued on the back of this process. The international economic situation has probably put the green paper and submissions made on foot of it on hold for now.
During our last period of lean in the 1980s Ireland had no formal regulatory approach to pensions. Since 1990 a regulatory framework has been in place. This has undoubtedly strengthened members' protection. But at the end of the day pension provision is, and is likely to remain, voluntary. It is doubtful if our economic recovery would be aided by the introduction of a mandatory pensions regime. So concentrating on enabling our economy to recover as soon as possible is probably the best solution for all concerned.