Irish pensions roundtable: change for the better
Written by European Pensions team
Chairman and Panel
Chairman for the day: Jerry Moriarty, Director of Policy, Irish Association of Pension Funds (IAPF)
Jerry Moriarty joined the Irish Association of Pension Funds in 2007 as director of policy. He was head of compliance with the Irish regulator, the Pensions Board, for six years. Between 1994 and 2001 he worked as a senior manager in various pensions technical roles with Sun Life Financial of Canada in the UK.
John Broker, FPMI - Director, ITM Limited
John provides advice and guidance to a wide range of ITM clients covering administration data management and consulting issues. John has recently been working in helping clients evolve strategies for data and systems management which enable data to be aligned to meet scheme objectives.
Kevin Coughlan, Vice President, J.P. Morgan Asset Management
Kevin is head of Ireland business with J.P. Morgan Asset Management with responsibility for provision of investment management services to institutional and wholesale clients in Ireland. He previously worked with Dexia Asset Management, Bank of Ireland Asset Management and Standard Life Investments in Ireland and the UK.
Dan DeKeizer, Chief Executive Officer, Metlife Assurance
Dan is an actuary and has held several senior leadership roles during 20 years with MetLife both in the US and overseas. Most recently he held a senior position in MetLife's retirement strategies group, New York, where he was responsible for financial, capital and risk management issues as well as product strategy and development.
Paul Glavin, Senior Consultant, Retirement and Investment Business, Aon Hewitt Associates
Paul began his career in the pensions industry with Irish Pensions Trust in 1988 and joined Becketts in 1999 as an executive director. Following Becketts acquisition by Hewitt Associates in 2003, he became a member of the executive management group of Hewitt Associates, now Aon Hewitt.
Martin Leech, Irish Institute of Pension Management (IIPM)
Martin has worked in the pensions industry in Ireland since 1970. All of this time has been spent working on occupational pension schemes with Irish Life Assurance, apart from a brief period in the UK in 1997–98 when he worked on the pensions opt-out review. He is also a council member and the vice president of the IIPM.
Michael Lernihan, Head of Defined Benefit Portfolio Management, Irish Life Investment Managers (ILIM)
Michael holds responsibility for the provision of investment services to ILIM's DB client base. He joined ILIM in August 2008 as a senior portfolio manager. Prior to this Michael was in the UK with Mercer Investment Consulting where he was responsible for the delivery of investment consulting services to large DB schemes.
Ray McKenna, Managing Consultant, Towers Watson
Ray McKenna is managing consultant at Towers Watson in Ireland and also leads the defined contribution team, which is the only dedicated DC practice in Ireland. Ray specialises in the design, implementation and communication of a wide range of reward programs including pensions and executive review.
Fionán O'Sullivan, Director, IFG Corporate Pensions
Fionán has overall responsibility for driving new business development of corporate pension schemes for IFG. Previously, Fionán held a number of senior positions in the Irish pensions industry, with in excess of 17 years experience. He is a Fellow of the Irish Institute of Pension Managers (FIIPM).
Recent economic turmoil
Chair [Jerry Moriarty]: Regarding the Irish pension system and the current economic climate, what has the impact been on the market, both on the pension funds and the providers?
Coughlan: I think there have been some interesting developments. There have been changes in ownership of a number of significant firms on the asset management side. Clarifying the position of those firms is a positive development for clients.
Leech: Confidence has shaken a lot over the last decade, it has got even worse again, and that is something we have got to address. But the confidence issue can be addressed in different ways. It is not just about asset recovery, it is also about education. I believe that is one of the biggest long-term issues coming out of this recent turmoil.
McKenna: The recent economic crisis has been a perfect storm for pension funds with significant drops in asset values, improvements in mortality and changes in interest rates, impacting on annuity costs. These factors combined with a challenging economical environment have certainly brought the pensions agenda to the fore for employers, trustees and members.
Moriarty: What about the impact on the revised tax limits in the budget. Changing the standard fund threshold, similar to the UK, is pulling back the ability of people to save as much as they want and they are probably likely to see more of that. So what is the impact of that on clients?
McKenna: The revised limits will certainly impact a greater number of members. This is increasingly getting attention particularly with speculation that there will be further reductions as set out in the new government partners’ manifestos.
Glavin: We should acknowledge that the Standard Fund Threshold in place pre-budget 2011 provided a generous cap which was availed of by a number of high profile individuals and therefore it was appropriate and necessary to address the level of the cap. I would have a concern however, that the reduced Standard Fund Threshold is affecting the very people employed by multinationals in Ireland that have the position and skill-set necessary to negotiate with their parent companies for investment in Ireland that would lead to job retention and creation. I do acknowledge and I would accept that there did need to be some steps taken, but I think the changes that have been made are too restrictive.
Moriarty: There is an argument focussing on the higher earners, the decision-makers, that if they are less engaged with the schemes themselves then they are not really bothered what happens for the rest of the workforce. Do you think that is a valid argument?
DeKeizer: I think that is something that has to be considered. If you look at the defined benefit marketplace, there are around two-thirds of schemes here in Ireland that are now closed to new members and about a quarter I think that have closed to new accrual. These steps are a signal from senior management that these types of plans are no longer key to attracting and retaining employees, and yet, from a social perspective, defined benefit provision was a good way to provide retirement income for the middle or lower earner.
But there are aspects in the budget proposal that support the social good, or the deferral of tax argument, that I think are reasonably well addressed. I particularly like the cap on the tax-free withdrawal at retirement. I know that people are more likely to save if they think they can get something back at or before retirement but placing a reasonable cap on the amount was probably a good move.
O’Sullivan: The government’s proposals to reduce the tax rate down to the levels they are proposing will be extremely detrimental to the ordinary middle income earner and the funding of the pension plans. We have done reports upon reports about how pensions should be put in place and then government after government continues to just go and do something completely different which is bizarre.
Moriarty: That brings us very neatly to the next question, which is basically what should the new government do?
McKenna: The most important thing is to have considered debate and consultation. In this time of flux we are seeing some decisions being made that will add to company costs, provide long-term issues in terms of prudent planning and are contrary to established social policy across all parties.
Leech: Usually fiscal policy is driven by short-term tax needs. Pensions policy should be long-term with some degree of certainty, the more the better. It also has to be fair and it is critical that savings remain an attractive option to people. That said, I think we all realise that the state needs money and so it is incumbent on the industry to engage with the government. Also that message has to be got out and with the sort of reputation that the pensions industry has, I am not sure that we are necessarily the best people to deliver that message.
Coughlan: Coming back to the political issue, I think the debate has been clouded and private pension provision has been unfairly targeted. Perhaps because there has been an element of tax planning, as we put it delicately in certain sectors. If those issues are a concern then they should be targeted specifically. Private provision becomes even more important against the back-drop of weaker state finances.
There is a trade-off here between the emergency requirement for revenue raising measures and sound policy development. I think people can accept a certain amount of pain, but there is potential to do very damaging things if the policies are implemented in haste.
Lernihan: To be a little bit more positive, we are in a situation where we have what appears to be a relatively stable majority in government so this does present an opportunity to plan more for the long-term and strategically address some of the difficulties facing the area of pension provision. There is the opportunity to learn from what has been successful across other European and OECD countries and implement a clear framework which then needs to be acted upon.
Measures such as asset grabs, reduction in tax relief to middle income workers and additional forms of taxation on assets accumulated are all hugely damaging to the longer-term objective of encouraging adequate private sector pension provision. The issue of applying levies to both DC and DB pension schemes without applying similar levies to ARFs and public sector pensions heightens the feeling amongst ordinary private sector workers that they are being unfairly targeted in the place of those with either significant private pots or secure public provisions.
O'Sullivan: They need to develop a clear longer-term strategy and simplify pension policy because it’s difficult for the general public to be passionate about something that appears so complex. Communic-ation and education, I think, has to be a priority. If you show or explain to people exactly the impact of delaying putting the money away, it shows people that they can actually provide a reasonable level of pension for themselves. Nobody is going to be a millionaire out of pensions but should afford individuals to have the comfort in retirement that they deserve after working for 30, 40 or 50 years.
Broker: Engagement is essential. I don't think that has happened to the degree it should have in the UK regarding auto-enrolment, where even now we are still uncertain about how it is going to work. Whatever happens it would be great if the outcome was clarity; with people being well informed quickly and provider solutions being delivered and administered at a reasonable cost.
Moriarty: I think everybody knows the basic concept that the NTMA is proposing to issue bonds of a duration that would be more attractive to pension funds than currently is the case. Funds can buy those bonds and take account of the higher yield for their funding standard position or annuity providers would provide annuities which funds can use to buy out pensioners at a better price than they can currently get on the market.
The government is very keen to say it is a proposal put to them by the Society of Actuaries and the Irish Association of Pension Funds last year, but that proposal was different to what they have come out with and circumstances in January last year in Ireland were very different to how they are today. So do people think it would help schemes, what are the pros and cons, what do the trustees need to think about?
O'Sullivan: I do believe this is a short-term solution which could create problems for the next generation and later retiring out of DB schemes. It brings very much to the forefront the conflict of interest issue for finance directors or managing directors who may sit on trustee boards, may be very close to the finishing line in their employment and they see this as a stop gap to make sure that the DB promise remains for them until they are gone and it is somebody else's promise or somebody else's problem to deal with once they have got their benefit. This issue needs to be addressed via effective legislation.
McKenna: Whilst any avenue to aid struggling DB schemes is welcome this, in isolation, will not address the crisis for the majority of these arrangements. Strangely this measure in isolation could hasten the closure of schemes.
Lernihan: There are also some additional concerns from an investment perspective. Given that Irish government bonds continue to trade in the market at a yield significantly above the yield which is being signalled from the proposed bonds behind sovereign annuities this provides a difficult question for Trustees considering the concept. Another difficulty is around the issue of risk transfer from predominantly active and deferred members in the current structure more towards pensioners under the proposals outlined.
Moriarty: Trustees might be very uncomfortable with going down the sovereign annuity route but the employer might be very persuasive in trying to get them to do that because it might be an easy exit from DB. You can leave with a clear conscience, but you know you have transferred all that risk that currently lies with the actives and deferreds to the pensioners?
Leech: Yes, in fact I think that they are a potential relief but I would be very worried if I was a trustee of a defined benefit scheme.
There could be pressure applied by an employer who is either unwilling or unable to pay more. Equally I could envisage a situation where if I go down the sovereign annuity route I could look after some of my existing members. I know a scheme where if they go the sovereign annuity route there would be money for the existing people, if they go non-sovereign route there would be nothing for the existing people. So what do you do? You are a trustee, you are stuck. You take all the advice in the world and no matter what decision you take somebody is going to be unhappy.
Moriarty: Next is the issue of de-risking, the approaches the scheme should be adopting and the tools available on de-risking. Also from an investment manager perspective, what are clients actually doing?
McKenna: A fundamental and well thought out review of investment strategy is required. Companies and trustees will be keen to get greater control over costs and investment strategy is key to this. However, greater cost certainty will need to be balanced against any short-term potential cost increases.
Lernihan: We are seeing a significant increase in the number of defined benefit schemes focussing on this area. Schemes are beginning to address the longer-term need to increase their exposure to defensive assets and reduce their exposure to equities and other growth assets. Schemes are increasingly focussed on the best strategic way to make this switch whilst maximising potential gains and minimising risk to the scheme.
Within this defensive allocation DB schemes are increasingly looking to invest in bonds that provide a reasonable hedge for the interest rate and inflation risks inherent in their underlying liability. This typically results in an increased allocation to longer dated nominal assets alongside the potential introduction of an allocation to inflation-linked assets.
Moriarty: Who's driving the process? Is it the employer, is it the trustees, is it a combination?
Glavin: In the context of the funding of the plan, the trustees generally will take the investment decisions although there may be a provision in the Trust Deed that gives the employer an input. So whilst the trustees will drive the de-risking issue, implementation may impact the funding required so from a practical perspective, it is a shared responsibility.
DeKeizer: We did a survey of finance directors and trustees in the late summer and we were actually surprised to find a very high number of Irish finance directors highly interested in de-risking their schemes. 76% in Ireland said that this was an important strategy, 32% of them said that it was very important. So that's a big number, bigger than the comparable numbers in the UK which were 63% and 16% respectively. But when they think about de-risking, they are still thinking about asset strategy, so either adjusting asset allocation or taking a step towards liability driven investment.
We get a lot of requests for buyouts particularly on the pensioner side as the legislation here allows trusts to buyout their pensioners and retain their deferred and active risks in the scheme. Almost all of what we see here in Ireland are schemes securing non-indexed benefits. In itself, this is another de-risking opportunity. The scheme may have indicated that it would provide CPI indexation, or a fixed 3% for example, but if the legislation allows you to do something that is less than that, you are passing a risk back to the members. So the communication with the members becomes an important issue at times like this. With equities recovered somewhat over the last year and interest rates starting to move up, it may be time when we see a lot of buyout activity here.
Broker: Enhanced transfer values is another form of de-risking –
I understand that happens here in Ireland – but perhaps that is something that comes up as part of a strategy to get to buyout. My worry is that it potentially ends up transferring quite a bit of risk onto a scheme member.
In the UK, because of data issues surrounding pension schemes buy -outs, we now have regulation in place around pension administration and data. In fact, The Pension Regulator in the UK has introduced a data standard. One of the key
worries they had was the poor quality of data being used in pension scheme buyout deals. The Regulator has now defined in the UK that you must hold certain data items to a certain standard, which is effectively 95% accuracy. It would be interesting to see, if the buyout market here in Ireland accelerates, whether or not there might be a similar data standard from the Irish Pensions Board. I think that is going to be create quite a shock and a lot of extra costs for pension scheme administrators here. Preparation is everything and communication to members is a critical part of that.
Moriarty: What about the tools developed for this?
Coughlan: There is an array of tools being developed. One of the issues is probably the amount of resources that schemes have to engage with. Some of the solutions can be quite complex, but if you have got either full time staff or the budget to pay for the appropriate advice that certainly makes you much better equipped to engage with some of the potential providers.
DC market evolution
Moriarty: How are Irish DC schemes evolving? Has much changed in the last year?
McKenna: The impact of the financial crisis combined with discussions of changes to DB plan design has started significant discussions on DC plans and whether they are fit for purpose in terms of design, investment strategy, communications and governance. DC is only a small part of overall retirement provision currently however, with the growth of DC, if a similar financial crisis were to occur in 15/20 years then the impact would be more significant with the greater dependence on DC.
Glavin: I think that there have been some developments. Absolute Return funds and Diversified funds have become a feature of many defined contribution plans whilst many DC plans have also had web access made available to the
members. One of the critical issues with defined contribution plans is education and I have seen nothing in the last 12 months that has enhanced the whole thrust around communication. Technology is a useful tool, it will help in terms of easier access to information 24/7 and so on, but it is only one element in a communication strategy.
Coughlan: I think it all comes back to the design of the plan because we shift all of the risk to the DC member. The people who are engaged enough to attend member presentations and make active decisions are not the issue. The issue is the vast bulk of people who will rely on what the scheme does for them without them intervening at all. So how we design the default and how you take people through the various stages is critical.
Broker: I would have thought given the funding situation for DB schemes that the DC concept would be extremely attractive. I think from a pension admin perspective it is pretty easy to administer a DC scheme. It is an accounting exercise, but you don't have the complexity that you have with DB. So I am interested in why there has been a slow take up in Ireland?
Moriarty: Part of the reason there has been a slower move out of DB to DC, has probably been the strength of trade unions, who are often dead set against DC. They are starting now to understand that actually, particularly for younger members, having your own account rather than having this vague promise of lower benefits and higher contributions, to effectively pay for people who retired before you even joined the company, can actually be a much better prospect for a lot of people.
McKenna: I think that DC has historically suffered as the 'poor relation' to DB plans. However, more sophisticated and appropriate scheme design and governance is changing this image particularly when combined with the reality of the problems facing DB plans.
O'Sullivan: A criticism of the industry would be that we have been fashion driven. In the early 90s it was all about with-profit managed funds and now it is all about lifestyle funds. All of these providers have lifestyling over their name, but they are all different and people haven't a clue what is actually happening underneath the bonnet. Where I see schemes evolving is in terms of flexibility within the schemes. For instance, potential drawdown facilities might be attractive to get people in, where at particular periods in their lifecycle like losing a job or redundancy, to access their money. I wouldn't be advocating the full amount because that again makes the long-term goal a problem, but it would attract people in at an earlier stage if they had some shorter timescale to see that they could actually do something construc-
tive with the fund when they most need it.
Moriarty: Alternative investments are solutions for smaller schemes that might be very attractive, but if you don't have the governance budget, you don't have the time to get into it. How do you get over that for smaller schemes?
McKenna: Whilst de-risking, and a more strategic approach to investment is important, consideration of the governance requirements is key. Surely if the governance budget is not available trustees need to keep changes simple and manageable.
Coughlan: The argument for alternatives is well understood, but one of the things that is striking when you review the asset allocation of Irish pension schemes is that the alternative allocations are still quite low at 3.5%. So I think that needs to change.
One of the issues though is around implementation. You make certain compromises when you go from very illiquid vehicles to more liquid strategies. It can make your diversified fund exhibit more equity like risk. So, those challenges have to be understood.
Moriarty: Where does the governance responsibility actually sit and how can recent developments in systems and data assist in improving administration, risk and good governance?
Broker: Governance clearly sits with the trustees in my view. I think investing money into a simple DC modelling tool, which would help increase people's interest, take-up and understanding would be one way of actually helping the case for DC move forward more quickly. With web-based technology being more available, I am asking myself whether in Ireland you would get
to a point where you could have more of a self-service culture. I don't think that has happened very much in the UK in terms of self administering pension schemes. And moving and making investment choices through the use of the internet would be a good way of also reducing the cost of pension admin.
I think, similarly to the UK, you have a NEST type structure coming in here and what is interesting is how would systems be used to collect that data and get people enrolled in a timely way and actually ensure the right money comes in at the right time. So straight-through- processing, collecting that money from a variety of very small employers and getting that through to the investment manager in a quick, safe, secure way, is another area where there is room for improvement to reduce risk and costs.
O'Sullivan: It has brought to the fore timelines that should have been there and should have been adhered to in the past. I would be an advocate of tighter deadlines, particularly around benefit statement issues. Members are more interested and concerned with online access and communication. It is 'what is my current value on a day-to-day basis' as opposed to receiving a benefit statement within five months. They want access to this information instantly and in realtime.
DeKeizer: Individuals are the ones that get paid so they ought to be interested a little bit in their pension regardless of who has the official responsibility. But the employer is writing the cheque. That employer covenant is so fundamental to the operation of the DB scheme, if not quite as much on the DC side, that it probably needs more analysis and thought than has been put into that in the past. You can go out and buy a Solvency II in-a-box system which you can spend a lot of money on or you can get an Excel version which costs you next to nothing. Either will let you have a quick look at the amount of risk capital your defined benefit plan would need if it were considered
an insurance company. In the end, that is what your employer covenant is worth.
If that Solvency II number is 300% of your employer's current equity, you are probably facing some problems in the future. If it is 5% of their current equity, happily go along your merry way. So, I think there are some tools out there for risk modelling that could help trustees exercise that governance responsibility more effectively.
Moriarty: Solvency II, do you believe that is what should actually happen for pension schemes?
McKenna: Before we consider Solvency II in terms of pension schemes we need a resolution to current funding uncertainty. Whilst all believe an objective and satisfactory approach to meeting liabilities is required the debate, more than ever, requires a measured approach.
DeKeizer: Solvency II is a known risk management standard so it might be a tool that could be used to measure what your employer covenant is worth or the risk that you are taking on in your scheme, but a pension scheme is not an insurance company, at least not yet under current legislation. Pension schemes have options that insurance companies don't. Particularly here in Ireland, with the ability to take the indexation away and to wind up and have active and deferred members getting a lot less than their employer promised them. So in that environment it doesn't feel right that you want to capitalise to the 99.5th percentile of your future risk.
Broker: I just wondered if I agree that we shouldn't apply that as a funding style to pensions schemes. There is an element of rigour that I like about Solvency II, particularly the focus on data. There is also a very stringent, enthusiastic approach being encouraged to be adopted for people who look very carefully in data and valuation of pension scheme liabilities. This is often an area that gets neglected.
A lot of assumptions are made about the accuracy of that data and the materiality of that data. Solvency II is bringing quite a healthy disciplined focus of what your liabilities are.
Public sector reform
Moriarty: Does anybody think it is not time to reform public sector pensions?
Glavin: I do think that it is time to reform public service pensions however this will not be an easy undertaking. One of the measures that has been addressed in some Government Departments is the approval process around the practice of providing additional benefits such as added years and enhanced early retirement benefits. This is very necessary because whilst these are paid out of day-to-day revenue, the capital value of such enhancements is a multiple of anywhere between 30 and 50 times the additional benefit, depending on the age of the public servant.
DeKeizer: I will say one positive thing about public sector pensions since we are in the pensions industry. We should be careful not to be too aggressively negative on what is being provided in the public sector. If you think about people we know or people in our own families that have retired with public sector pensions, you know they are not travelling around the world every year, they have got enough to live on and that is kind of what we all hope for when we reach that age. So as we think about reform, which is necessary, it shouldn't be reform in the sense of 'let's figure out how to get rid of these pensions'. We are in the pensions industry, we want to encourage good pensions,
well funded and well administered, especially for the average and lower earners who will have little else.
Moriarty: Last question. Are mandatory pensions the way forward for Ireland?
McKenna: Whilst the goal of 100% coverage is on one hand admirable it needs to be balanced against the need, practicality and potential impact on existing retirement provision. Lessons learnt from other jurisdictions need to be considered.
O'Sullivan: The potential danger of mandatory pension is that you go to the lowest common denominator and that existing schemes will just pull back to what they can least put in, which would undermine the objective. They have however worked very successfully in Australia, so we should take some lessons from their model. I would strongly advocate some form of compulsory communication and education and every member, within the public or private sector, would need to participate in an education programme, understand what pensions are about and what steps they need to take to provide themselves with an adequate retirement fund.
Lernihan: Anything that potentially increases the wider coverage of pensions in the workforce is obviously welcome. However, it should be acknowledged that this is only the first step towards ensuring that employees have adequate pension provision. Mandatory pensions do little to address the issue of the potential adequacy of pension provision. The introduction of mandatory schemes needs to be coupled with a communication and educational agenda to ensure that members have a realistic understanding of the potential benefit that the relatively low contribution rate proposed is likely to deliver. Focussing on contribution rates, it is important that this proposal is understood as an initiative to include employees that are currently outside the pension system rather than being perceived as an acceptable industry standard rate for existing DC schemes.
Glavin: I remain to be convinced on this point. Increased coverage cannot be at the expense of adequacy so there needs to be a balance between the two. We all know that low contributions paid in isn't going to provide a sustainable benefit in retirement so for me, those concerns must be addressed from the outset.
Moriarty: Well we do keep trying to highlight the work that NEST has done in the UK. There have been a few hundred people working there for six years now trying to put it all together, have spent tens of millions doing that and still the jury is out on whether they will get it right or not.
In summary, we are seeing a lot of action around the de-risking space in the DB market, not so much in the DC side. I keep thinking myself we need to bring some of the thinking and time and energy we put into DB across to DC. Sovereign annuities I think very much jury is out. I don't think anybody thinks it is a long-term solution to anything.
I think the whole data issue is interesting. We spend a lot of time looking at a lot of higher level issues when sorting your data out can help a lot. We have some disagreement on mandatory pensions. I think that whole issue of who are we trying to provide for and what are we trying to provide, hasn't been dissected yet.