Serious Money: First steps to fixing our ‘broken’ pension system
The key practical steps required for meaningful reform are widely understood and broadly agreed, but the policymakers and legislators have, until now, been reluctant to tackle this issue with the appropriate level of urgency
The test of success for any pensions system is that it provides adequate income in retirement for our citizens. This requires our working population to save a meaningful portion of their income over a long period of time. They will only do this if they are confident that this financial commitment will be honoured in full when they reach retirement age.
That in turn requires us to have a pension system that is equitable, sustainable and understandable.
Our current pension system is failing that test and strong leadership is needed to restore the confidence of demoralised participants and frustrated employers and trustees. The key practical steps required for meaningful reform are widely understood and broadly agreed, but the policymakers and legislators have, until now, been reluctant to tackle this issue with the appropriate level of urgency.
Protecting past promises
Our system primarily comprises two types of pension provision:
Defined benefit (DB), where an employer makes a pension commitment to their employees, normally based on earnings and length of service; l
Defined contribution (DC), where employers and employees jointly contribute into an account which is then used to purchase a pension at retirement.
The traditional view was that DB is superior to DC but the ever increasing cost of providing pensions has meant that DB scheme members are now facing the reality that there are insufficient assets available to fully meet these promises.
The high cost to employers of meeting their pension commitments has been exacerbated by the imposition of levies, risk reserves, short funding periods and continuation of a funding standard linked to German bond yields. These barriers need to be removed to give DB pension schemes a realistic opportunity to restore solvency in an affordable way.
The excessive burden currently imposed is causing increasing numbers of DB schemes to wind up prematurely and pay out benefits which are below member expectations. The Society of Actuaries and the Irish Association of Pension Funds (IAPF), with the support of employers group Ibec and the Irish Congress of Trade Unions, have proposed a way to improve the fairness of the balance of security between those who are yet to retire and those who have retired already. To date the Government has not acted on that proposal and continuing uncertainty is eroding already battered confidence in the DB system.
Sustainable future pension provision
As we transition from a DB model to DC, it is vital that we avoid the mistakes of the past. Broad reform is required because the complexity of our regime is now undermining the sustainability even of the DC system. If employees struggle to understand the rules, they will resist making adequate provision for their retirement.
Hopes were raised when the Pensions Board – which refulates the sector – completed a consultation process on how to simplify pension provision in April 2012. However, it is now over a year since that exercise was completed and nothing has happened. It is imperative that the board acts soon to simplyfy the regime.
Currently, when a DB scheme winds up, members who have not yet retired transfer to a Personal Retirement Bond (PRB). These are essentially DC arrangements but cannot access Approved Retirement Funds (ARFs) for cash draw-down at retirement. All other DC scheme members can avail of ARFs which are particularly valuable at a time when annuities are so expensive. Why can this anomaly not be addressed?
Reforms needed to restore confidence
There are four very practical steps which would make the Irish pensions system more equitable, more sustainable and more understandable:
1. Reduce the short term financial burdens on DB pension schemes that are artificially inflating the cost. Also, if a scheme is forced to wind up, introduce a fairer distribution of assets.
2. Simplify and standardise the DC pensions system to make it easier to understand. The pensions regulator has noted thatIreland has an inordinately high number of very small DC schemes, which tends to impair member outcomes.
3. Encourage dialogue and strong engagement between government departments, Revenue Commissioners, the pensions industry and, most importantly, the members themselves.
4. When economic circumstances stabilise, we should move towards an auto-enrolment system so that we can ensure everyone is making adequate provision for their retirement.
If implemented, these measures would create significant cost efficiencies and an improved competitive environment, driving better outcomes for those pension members who should be at the heart of our considerations.
Niall O’Callaghan, is a partner and DC Leader at Mercer Ireland.