Government faces pensions funding time bomb

If the Government continues with its pay-as-you-go method of funding social welfare pensions, it could absorb 8 per cent of GNP in the next century, according to the new report from the Irish Pensions Board (IPB).

The central message from Securing Retirement Income, the IPB's submission to the Government, is that basic pension schemes do not come cheap.

It is not a document that can be left to gather dust. Because it was drawn up by the National Pensions Policy Initiative (NPPI), which has trade union and employer representatives on it as well as pension experts, it has to be referred to the central review committee of Partnership 2000 for consideration.

The single most important proposal, that old-age pensions be increased from 27 per cent of average industrial earnings to 34 per cent within five to 10 years, is in line with the Government's own commitment to increase

old-age pensions to £100 a week by 2002. But the report also deals with how to reach the 54 per cent of the working population who have no supplementary occupational pension scheme at present.

The report devotes its recommendations to addressing the two main pillars of the existing pension system: the first pillar is the social welfare scheme and the second pillar is the voluntary, privately-funded pension sector. At present, almost 90 per cent of the 387,400 people aged over 66 are in receipt of an oldage pension from the State. In relation to second pillar cover, the figure is only 46 per cent for those presently at work.

While the figure for those with private pensions is 52 per cent among employees, it falls to 27 per cent for the self-employed. There are also wide variations in cover between occupations. Those in high-income jobs in sectors like financial services have up to 100 per cent involvement in pension schemes, but the average drops as low as 3 per cent in many lowpaid and atypical employment sectors.

Of the 520,000 workers in occupational pension schemes, 419,000 are in the traditional defined benefit schemes, which link pension entitlements to years of service, and 101,000 are in defined contribution schemes where the pension is determined by the amount paid.

The NPPI saw its main priorities as: establishing Social Welfare pensions at a level to provide an "adequate income to all, with the associated effect on employment costs or taxation"; raising people's awareness of the need to plan financially for retirement; making supplementary pensions more accessible to the low paid and self-employed; and simplifying the system for both employers and employed.

Unlike the rest of the EU, Ireland's demographic "time bomb" has another 20 years of ticking ahead before it explodes. The report says that the elderly dependency ratio will actually decline between 1991 and 2006. This provides an opportunity to begin making provision for decent pensions before the population aged 66 and over rises dramatically from 414,000 at present to 1,018,000 by 2056.

Turning to the first pillar, the report predicts that, if the present system of linking Social Welfare pensions to prices is pursued, pensioners will receive 2.6 per cent of GNP by 2056, compared with 4.8 per cent today. If pensions are linked to wages instead, then they will cost 8 per cent of GNP by 2056.

If the Social Welfare pension is set at 34 per cent of average industrial earnings, which are currently £291 a week, then it might be possible to cap Exchequer contributions at 3.5 per cent of GNP. If the pay-as-you-go system remains unchanged the cost to the Exchequer of maintaining a 34 per cent link to average industrial earning would be 7.4 per cent of GNP.

The NPPI says that the Exchequer pension bill can be capped at 3.5 per cent by establishing a designated investment fund immediately. This fund would require annual contributions of £250 million for the five years from 1999 to 2003 and annual contributions of £500 million over the following five years. These payments would be followed by an annual investment equivalent to 50 per cent of projected PRSI contributions. The fund would reach £31 billion by 2031, or about 26 per cent of GNP. These figures are based on a relatively modest 5 per cent return on assets in real terms.

The programme would require Exchequer contributions to grow from 1.7 per cent of GNP at present to 3.5 per cent over the next 20 years. The report says that this additional financial outlay by the Exchequer "could be met, at least in the earlier years, from realised or other gains". This presumably includes the sale of semi-state companies.

However, it warns that the proposed funding mechanism would "be largely nullified if it led to additional borrowing by the Government. In that case the mechanism would in effect not lead to any additional saving by the current working generation, and would not resolve the issues of fairness and risk".

The report does not recommend how to address the thorny issue of increased PRSI contributions which its funding programme implies. It notes that employers' representatives on the IPB, while they agreed with the board's aspiration to give workers a pension equivalent to 34 per cent of the average industrial wage, said they could not give unconditional support to the recommendation.

This was largely because of the implications of increased employers' PRSI, which would reverse the trend in recent budgets. The report itself says that achieving the 34 per cent target "would not entail significant downside risks to the current macro-economic projections for the next five years, or so, of continued rapid economic growth with strong increases in employment". However, it does acknowledge that "for labour intensive industries the impact could be significant".

Ironically this is the sector where low pay abounds and where a higher old-age pension would have the most beneficial effect in combating social exclusion. This is also the group that the NPPI targets in its second pillar proposals. At present high administrative costs for small and individual pension plans, avoidable investment and annuity risks, problems of servicing a highly mobile workforce and lack of information, militate against many low-paid workers in atypical employment joining existing pension schemes.

The report recommends that employers provide mandatory access to a low-cost Personal Retirement Savings Account (PRSA) for all employees, including those who are temporary, part-time or on a contract.

The report stops short of calling for mandatory contributions by employees, employers or the self-employed to PRSAs in the immediate future, but it says compulsion should be considered if it is ascertained that "insufficient progress has been made towards the targets". The first review should take place five years after the PRSA system comes into operation.

The NPPI sets relatively modest targets. It says that 53 per cent of workers should be in occupational schemes within five years, and 57 per cent within 10 years.

The PRSA should also be "a new type of pension vehicle. . . aimed at meeting the needs of the flexible labour market of today without undermining existing good provision, especially in defined benefit schemes". The PRSA would be governed by the same regulatory bodies as other schemes and contributions would be tax deductible. To reflect the uneven earning patterns there should be provision to roll-over tax relief and to allow for lump sums to be paid.

Access providers would include banks, building societies, credit unions and trade unions. The NPPI report says safeguards should be put in place to ensure the introduction of PRSAs do not result in inferior pension products that supplant existing ones.