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Dublin: 11 °C Thursday 24 April, 2014

Column: Is there any certainty for pensions?

Last month, the Polish government moved assets out of private pensions into unfunded public pension schemes to reduce sovereign debt. Could something similar ever happen in Ireland? Samantha McConnell discusses.

Samantha McConnell

THERE WAS A frightening headline on an article in finance magazine Eurohedge recently: “Poland Confiscates Half of Private Pension Funds to ‘Cut’ Sovereign Debt Load”. It sounds unbelievable, but effectively that is what the Polish government did last month – it moved the assets out of the private sector and into the unfunded public pension scheme, in the process allowing it to reduce its debt load.

The Irish Government should certainly not consider following the Polish example of taking over all pension assets in the private sector to pay for insolvent Defined Benefit schemes.

Defined benefit (DB) schemes can be very appealing during times of economic stability or growth and when a country has a robust, young workforce to support it. In this scenario, employers are sure to be able to meet their obligations, possibly with funds to spare for further investment.

But with an increasingly aging workforce, it becomes more difficult for businesses to meet these obligations, particularly in combination with an erratic economy. This scenario puts an added burden on the business and creates animosity amongst current employees who are in the DB scheme and are concerned about their pension prospects.

Defined contribution

This is why defined contribution (DC) plans have become so popular. The employee pays into their own fund and the employer may also contribute an agreed upon amount. This relieves the employer of the burden of having to find the resources to fund the employees’ pension and relieves the employee of the concern that their pension will not be available when they retire.

Because a DC pension is based on what has been accumulated in the fund rather than on a final salary, it provides further reassurance to the employer.

We are not suggesting that the Irish Government is about to engage in a further raid on pension funds but lest we forget our Government did something very similar with the funded pension schemes of the universities in 2009. Nationalising those pension schemes allowed the Government to take all the assets on to the balance sheet, assume the liabilities and add them to the unfunded pay-as-you-go public sector pension fund, which is ultimately paid for by the ordinary tax payer. At another time the National Pension Reserve Fund was also raided to bail out the banks. Short-term win for long-term pain seems to be the preferred route.

Poland is not the only European government to have filled a budgetary gap using pension funds in recent years.

Dipping into private pensions

In 2011, Hungary practically seized private pension fund assets, giving Hungarian citizens an ultimatum: they could either remit their individual retirement savings to the state, or lose the right to the basic state pension entirely (and still have an obligation to continue to pay contributions for it). In this way, the Hungarian government gained control over approximately €11 billion of individual retirement savings they used to lower the national debt. Bulgaria and France have also dipped their hands into private pension schemes at different times. In all of these cases, the funds were used to plug short-term deficits without implementing any reform and at the cost, I would argue, of the long-term sustainability of the system.

The move by the Polish government was a very extreme example, but it served to illustrate what can happen where there are two diametrically-opposed goals.

The Polish experience highlights again the necessity to take pensions out of the political arena. In Ireland, there is a need to establish a non-political body that can plan a long-term strategy to deal with the pension crisis without the requirement to consider short-term political necessities.

The Waterford Crystal case is due back into the courts shortly. How long it will take until a decision is made is anyone’s guess at this stage. Nevertheless, at some point the piper will need to be paid. How much the figure will be is not yet known, but I do suspect that the Government will be very unlikely to carry the cost.

I can foresee a number of ways to deal with this issue. One of them could be for the Government to take over the assets and liabilities of double insolvent schemes and pay out benefits on a pro rata basis to the assets using sovereign bonds to underwrite the payments. For this to work, the Government needs to address the priority order issue and also needs to ensure that payments out do not exceed the assets taken over or else the cost will come back to the taxpayer.

While I don’t believe this is the way to go, the Government could nationalise all DB pension schemes and use the assets to fund all benefits up to a certain median level, effectively using the assets of well-funded schemes to fund those that are less well funded. The assets would need to be ring-fenced to fund the benefits and all benefits would need to be capped. I don’t believe this likely to happen in the current environment, but it is an option.

The most likely outcome?

A more likely outcome is that a further levy or otherwise named charge on pension schemes is introduced to fund the reparations made to members of double insolvent schemes where the benefits paid out were below an acceptable level.

We would argue that Defined Contribution scheme members who already bear the risk that their pension will not be adequate in retirement should not be liable to paying the cost of insolvent schemes.

More often than not Defined Contribution scheme members are already carrying the majority of the cost of funding for their own retirement and in most cases their pension at retirement will be a fraction of that enjoyed by those who reach retirement in a functioning Defined Benefit scheme.

It should be those in Defined Benefit schemes funding the cost but a further detail to decide is who bears what exactly.

Is it fair that well run schemes should fund up, or do we pass the burden to those schemes already struggling? In my opinion, whichever way we eventually decide to tackle this issue it will serve to hasten the end of Defined Benefit pension schemes.

Samantha McConnell, Chief Investment Officer, IFG Corporate Pensions

Read: Higher rate of Invalidity Pension to be phased out
Read: “Pensioners should pay for their TV licences and travel” – Michael O’Leary

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