EMU poses problems for pension funds

The introduction of decimalisation in February 1971 was confusing. Overnight, 240 pence in the pound became 100 pence. Whilst the headline in The Irish Times the following day was "Decimals not so difficult after all", it added: "Problems in change worry older shoppers". European Monetary Union is far more complex than decimalisation because there is a complete change in currency. After decimalisation, the pound was still the pound. With the euro there is no convenient exchange. As well as one penny not equalling one cent in the euro, one pound will not equal one euro. Unlike decimalisation, there will be a phased introduction of the euro. From January 1st, 1999, the exchange rates of the currencies of those member states which join EMU will be fixed irrevocably. . From 1999 also, there will be a transition period before the euro notes and coins are introduced. It is not certain when this period will end, but it is expected to be, at the latest, January 1st, 2002. At that point, the new notes and coins will come into circulation and retail prices will be expressed in euros. For the first six months of 2002 (at most), pounds will continue in circulation alongside the euro, and there will be a dual pricing regime where both the pound and euro equivalent prices will be displayed for the consumer. Dual pricing will probably be introduced earlier, during the transition period. Pounds will cease to be legal tender by July 1st, 2002. EMU will impact upon pension funds primarily in six areas: investment, administration, communication, legal documentation, technology and timing.

Investment: At present, pensions are payable in Irish pounds. That means pension funds are taking an exchange rate risk by investing in foreign quoted securities. This is why pension funds hold approximately 60 per cent of total assets in Irish securities.

Assuming we enter monetary union, salaries and pensions will be payable in euros. The exchange risk will be eliminated where investments are euro-denominated. The risk will, of course, remain for investments outside the EMU, such as dollar and yen securities, and perhaps sterling, if the UK stays out.

A move to a single currency is likely to result in investment managers increasing overseas investments in order to enhance liquidity and diversity without currency risk, assuming that satisfactory alternative investments can be identified. Therefore, an outflow of funds from Ireland is likely, although only time will tell how significant this will be. Trustees will need to review the asset allocation and stock selection strategies of their investment managers.

EMU is expected to herald a long-term low interest rate environment, which means that the cost of buying a pension through an annuity will be high. To some extent this will be compensated for by the fact that inflation-proofing of pensions will be cheaper to secure, but funding for fixed cost pensions will go up.

Administration: The biggest impact of EMU will be on the administration managers to a pension scheme, as financial and membership data will change with the adoption of the euro The switch to euros will largely be dictated by when the employer moves to euros in its accounting systems.

Investment managers will also have problems as they may have to report fund values in both currencies during the transition.

Communications: The key disclosure requirements for pension schemes are the annual report, accounts (for larger schemes), benefit statements and, for defined benefit schemes, the actuarial valuation and funding certificate. There is also the explanatory booklet and the trust deed and rules.

Effective communication will require dual currency statements during the transition period rather than waiting until 2002. Annual reports should include euro and pound equivalents, as should individual benefit statements. It would be desirable for actuarial valuations to express assets and liabilities in terms of both euros and pounds.

Larger schemes and insurance companies may need to establish help desks to respond to queries from members. The earlier the communication exercise is started the better. To wait until 2002, when the new money is in circulation, is too late.

Legal Documentation: The formal rules of the scheme may need to be revised if any benefit is expressed in pounds. If there are insured benefits, new insurance policies will probably be needed. Technology: The change to euros will hit information technology departments right at the time when they are already grappling with the year 2000 problem. However, whilst year 2000 is a major technology issue, the difficulties in conversion to euros should be more modest. How big an impact the euro will have on systems will largely depend on the ability to make changes to existing systems, either in-house or from the original supplier.

Timing issues: To achieve a clean switch to euros, the trustees of a pension fund should endeavour to change over to euros at the annual renewal date. Otherwise data will change to eeuros during the pension scheme year which will cause accounting and administration complications.

1. Pension administrators should start reviewing their pensions administration systems immediately. Staff training will be required.

2. Trustees should liaise with the employer in order to co-ordinate and plan their strategies for implementing the changeover to euros. 3. How the conversion to euros should be communicated to members, in particular pensioners, is vitally important and will need careful planning.

4. Investment managers need to report to the pension fund trustees on how they see their investment strategies changing after EMU.

5. Investment managers should agree on how they propose to handle the reporting of fund values to the trustees.

6. A documentation audit should be carried out to determine what changes are required to booklets, deeds, policies and benefit statements.

Kevin Finucane is Director/Pensions Legal Adviser at Coyle Hamilton Employee Benefits & Investments.