Pensions industry unlikely to cope with sustained attacks


ECONOMICS:Government should switch focus to build-up of unfunded public pension liabilities and public sector wage bill

THE PENSIONS industry is under attack on multiple fronts and is suffering harsher treatment than that meted out to any other sector.

Yet the response has been surprisingly muted, in contrast to the situation a few years ago when the grey brigade took to the streets over the relatively minor matter of free medical cards.

First, there is the levy which is designed to expropriate 2.4 per cent of accumulated pensions savings but one-quarter of which is likely to come from enforced reductions in pensions income.

Then there is the consultation paper on defined benefit (DB) pensions. Already 75 per cent of DB funds are in deficit but this seeks to raise the minimum funding standard, pushing even more funds into deficit and accelerating the demise of the sector.

Finally, there is the provision in the bailout programme to lower the tax relief on pension contributions to 20 per cent which will make it uneconomic for higher taxpayers to save, drastically reducing inflows into pension funds.

On their own, any one of these would be a serious blow; together, they are likely to wipe out the industry as we know it. In addition, both the ceiling on tax relieved funds and the tax free lump sum have been sharply reduced and companies are taking their own action by switching to less generous hybrid or defined contribution schemes.

The decision by the Commission on Taxation to recommend a composite 33 per cent relief rate is hard to understand. The subsequent proposal in the bailout plan to reduce it to 20 per cent is inexplicable.

It means higher rate taxpayers would be relieved at 20 per cent on the way in and taxed at 47 per cent on the way out making it illogical for them to save in this manner.

This was the context in which some industry representatives proposed a levy on accumulated pension fund assets. In so doing, they may have shot themselves in the foot for the levy, instead of being an alternative to lower tax relief, now looks like being in addition to it as the Minister has merely committed to looking at the situation. Any change to the IMF programme must be offset by savings elsewhere.

The draft levy legislation contains serious anomalies. Pensions in payment from ARFs (Approved Retirement Funds) and some PRSAs are, rightly in my view, exempted. However, pensioners in DB schemes which are in deficit will likely see their incomes fall as it gives trustees the power to reduce payments to existing pensioners, an unusual and unwelcome departure from standard practice which opens up the possibility that unscrupulous employers will cut pensions by more than is warranted by the levy. It is also contrary to standard pensions policy in that the more you have saved, the greater the hit.

The IAPF calculates that the levy could reduce pensions in payment by 9 per cent per annum for the four-year period (due to the gearing effect) or by 2.5 per cent if averaged over the rest of a pensioners life; in this case, it would obviously hit income rather than the stated target, savings.

The effective marginal tax rate on those affected would rise from 47 per cent to 52 per cent for the four-year period, leaving them paying more tax than any other group in society, hardly the intention of the Minister and inconsistent with the treatment of other pensioners in both the public and private sectors.

I searched in vain for a copy of the proposal on the Minimum Funding Standard (MFS) only to find out that the document, dated April 28th, was not published but rather issued to selected industry bodies with a one-month deadline for comment.

It proposes more conservative standards – the two main options would increase liabilities by 10 to 50 per cent – and, thus, increased funding at a time when most industry bodies favour a relaxation.

It has been described as hasty, ill conceived and contrary to social policy.

Though cut by about 4 per cent on average in the 2011 Budget, public sector pensions are still gold plated by comparison. They are valued for tax threshold purposes on a 20:1 ratio, that is, every €100,000 of pension is deemed equivalent to a fund of €2 million. This is a gross understatement. Private sector actuaries value such pensions at 30:1, reflecting their indexation to income rather than prices.

I only recently discovered that pension increases are at the discretion of the Minister for Finance. In his 2010 budget, Brian Lenihan proposed to switch the link from incomes to prices, thereby saving €20 billion, but this was subsequently dropped.

The cost of unfunded public sector pensions is now put at €130 billion, probably an underestimate. The hidden pension liability is, thus, nearly the same size as the gross national debt about which there is so much debate.

The crisis in private pensions is fairly obvious and is being exacerbated by official action. A similar crisis in public pensions is hidden with very little action.

The situation is exacerbated by added years. In the private sector if you retire five years early, your pension goes down by 25 per cent; for 10 years it halves.

As gardaí are allowed retire on full pension after 30 years service, it follows that half their pension is a gift, presumably reflecting the stressful nature of the job. The Army can retire on full pension after only 20 years service and the judiciary after an amazing 15 years. If such pensions were funded, the annual contribution would be in excess of 100 per cent of salary. Their remuneration is, thus, more than twice what it seems.

Academics, too, are in on the act. Not content with awarding themselves pay increases they were not entitled to, it now emerges that the practice of added years on retirement is so widespread that one university claimed it was part of their conditions of service. Additions of five to 10 years are not uncommon, that is the unfunded cost rises by 25 to 50 per cent at the stroke of a pen.

More generally, there is insufficient focus on the public sector pay bill. The public finances have deteriorated alarmingly since early 2010 yet there has been no radical review of the Croke Park agreement.

Per capita national income – average income in the State – has fallen from 114 to 92 per cent of the EU average, putting us back at 1997 levels and wiping out a decade and a half of progress. Despite the fiction, still aired abroad, that we have high relative income, we are now at the bottom of the EU15 league, save for Greece, Italy, Spain and Portugal.

When it comes to the public sector wage bill, the reverse is the case. Here, Ireland is fourth from the top with only Denmark, Finland and Sweden above us.

Cuts in the wage bill have been modest – see chart – even allowing for the likelihood that the impact of Croke Park will be more evident in 2011.

To bring the wage bill back to the EU average would necessitate reducing the 2010 spend by €2.5 billion. To pare it back in line with the fall in income in the economy as a whole would require more radical action, almost €4 billion, while a return to the relativities that existed in 2000, when the economy was in broad equilibrium prior to the property bubble, would imply a massive €6 billion adjustment.

Our present malaise is such that no sector can escape unscathed. However, the focus on private pensions, a soft option, seems excessive.

The Government would do well to turn their attention to the alarming build-up of unfunded public sector pension liabilities and, more generally, to the still bloated public sector wage bill.

Pat McArdle is a former pension fund trustee.