Written by European Pensions team
Chair: Jerry Moriarty, Director of Policy, Irish Association of Pension Funds
Colin Doyle, Associate Director, Pension Solutions Group, Russell Investments
Martin Leech, President, Irish Institute of Pensions Management
Nicholas McShane, Head of DB Portfolio Management, Irish Life Investment Managers
James McConville, Partner, McDowell Purcell
Frank O’Riordan, Director, AIB Pension Fund
Chair (Jerry Moriarty): What is the current sentiment among Irish pension schemes and providers, and why?
O’Riordan: Generally speaking pension funds are in a better position now solvency-wise than they have been for some time. No-one’s pretending that we’re there or even nearly there. Bond yields have gone up and asset values have gone up. It’s been a happy combination.
McConville: The investment position has improved and, on the DC side, where investment sentiment is improving those schemes will run themselves. But it’s not entirely risk-free because you’ve got the issue of the pension levy and the issue of whether or not DC schemes should be funding insolvent DB schemes. Then you’ve got employees out there looking at this and saying ‘what is happening to pensions, is it worth saving for a pension?’. How are we going to make it attractive for people to come back to pensions, or are we going to force people back to pensions? There isn’t much enthusiasm for saving for pensions right now and that’s obviously going to create problems for the industry down the line.
McShane: The last number of years has been dominated by a lot of negative sentiment brought about by the significant legislative and regulatory change and an acceleration of DB scheme closures, wind-ups and benefit cuts. The Pensions Board has estimated that around 60 per cent of DB schemes remain underfunded. In addition, we have seen some very high profile cases that have added to the negativity – Irish Airlines, Waterford Crystal and more recently Element Six. But we are seeing significant positive engagement with the surviving schemes, both from the trustees and sponsoring employers, regarding the long term viability and sustainability of their particular schemes. As part of this engagement, we are seeing a renewed focus on the need to implement
less risky and bespoke investment solutions in a structured, integrated and planned way.
One of the live issues facing schemes however is the move to bonds at any expense brought about by the regulatory framework. We have a number of clients who have banked recent gains in markets, but these schemes have been very reluctant to invest in bonds at current levels.
Doyle: The general tone is one of optimism, but you’re right that there persists a stubborn theme of complexity for both DB and DC schemes, particularly around investments. That’s probably why increased delegation is becoming more talked about. Employed appropriately and consistently with each trustee group’s specific requirements and preferences, this can mean that schemes, trustees and sponsors can get much greater assurance that they’re equipping themselves to successfully achieve the overall objectives of the scheme.
Leech: There’s still an issue that the ordinary member doesn’t really know what’s going on within the industry. The industry has to address the communication, or lack of it, with members in both DB and DC schemes because there have been so many people disappointed with pensions.
Chair: I meet people all the time who say their pension has gone to pot altogether. It probably had, but it’s probably not anymore, people just read the negatives and think that applies to them.
O’Riordan: The industry is saying that people aren’t contributing enough to DC schemes, not half enough. We know this, and we know the reasons. But just going back to Jamie’s point, people see pensions and they think of bad news. But they’re putting money into property, they see that as every bit as much of a saving or investment as a pension. It’s very disappointing that people aren’t putting money into pensions, but in some respects they are saving for themselves.
McShane: People see property as a tangible asset. Part of the problem with pensions is that it is regarded as intangible for a number of reasons. People are put off by the language of pensions, and accessibility is also an issue. You can log on to your bank account from anywhere anytime, can you log in to view your pension investments and transact? Making it more tangible for the individual is one of the key challenges for the industry. We have seen some progress in this area with the development of smartphone apps along the lines of banking apps, but take-up remains low.
McConville: One of the places in the world where they have the highest public engagement with their pensions is Australia. Why? Because it’s compulsory. You have a vested interest. We have to eventually move to a mandatory system, because it is one way of simply getting the public engaged. Recently there was a lady over from New Zealand who was talking about the KiwiSaver. That’s probably the system that’s closest to the auto-enrolment that we have in mind here. But she said ultimately she was only going to give that system 6/10 - that was about public engagement as well as overall performance. It’s going to be very difficult to get the public more engaged until they feel that it’s something they have to do as opposed to something they could do.
Leech: I heard Bill Kyle, the CEO of Irish Life who has a Canadian background, talking about auto-enrolment and the whole system in Canada. They had intended that it would be state run, but when they got to look at the detail they realised it couldn’t really handle it, and they had to engage with the industry that already existed there. There’s opportunities for us in this as well, I don’t see it as a threat. But we need to get in and talk to the people who make the policy decisions.
Chair: It’s difficult when you’re effectively trying to force people into doing something you’re assuming they’re not doing because they don’t want to. Is auto-enrolment the way you deal with adequacy, it or should it be mandatory?
McShane: Clearly it’s in everyone’s interest to provide for retirement but auto-enrolment with an inadequate contribution rate is not a credible or effective policy response. Given the current economic climate and the fall in disposable income over the past five years, it’s very difficult to get people engaged in terms of mandatory contributions to pension schemes. Mandatory pensions are viewed as a further tax and in the current climate of property tax and water charges that is not politically acceptable. An option that could be considered is pre-commitment of pension contribution levels. The current economic environment is not conducive to appropriate EE and/or ER contribution levels. But similar to Australia the contribution rates could commence at an acceptable level for the current economic environment and increase via a pension provision road map. Auto-enrolment under this scenario would be matched through time with adequacy of contribution rates. Government have already used a similar policy in relation to the retirement age.
McConville: You could say: ‘On January 2020 we’re going to start with a mandatory system, you can opt in to that system beforehand, or we will auto-enrol you in the meantime. You can opt out but you can’t opt out after 1 January 2020, and if you’ve opted out then you’re back in’. Maybe draw a line in the sand and say we have to think about the fact that we’re going to fall from a pensioner/worker ratio of 5:1 to 2:1 by 2050. 2020 gives us 30 years to really work that one out.
Doyle: If you start the discussion about ‘mandatory’ now then it gets people’s attention. Whether or not mandatory is ultimately the right answer, at least by doing that you’ll definitely generate interest, discussion and engagement with people. People will either recognise that this is the right thing to do or something else will have been agreed before then.
O’Riordan: There has to be a way of getting this really moving. It has to be seen not to come from the pension industry, because it will just look like giving ourselves jobs. It would seem to me to have to come from the employers, the unions. It has to be seen as non-party political.
Chair: The great thing about the Australian system is its employer contributions. Instead of giving all employees a 5 per cent pay rise they got a 2 per cent pay rise and 3 per cent into your pension. So people don’t look at is as an individual tax on themselves. Also in a DC context people are less loss-averse when it’s employer contributions rather than their own contributions. They’re a bit more relaxed about investment performance.
Leech: We have a very good basic system here. Social welfare payments to a certain level, then tax incentives to another level, and after that you can keep going but you won’t get the tax supports. We’ve got machinery and products within the industry. But although they’re interlinked we must separately identify pensions from tax. The government is going to have to adjust tax from year to year while pensions are so long term. It’s something that as an industry we should bring to the regulator or to government, or whoever is going to be the influencer on this. All of us need to be aware of the different “personalities” of tax and pensions.
Chair: Last year the regulator said he would like to see no more than 100 DC schemes in Ireland. Industry schemes, centralised schemes, master trusts, moving away from individual employer sponsored arrangements. What are our thoughts on that?
Leech: There’s a risk there that you have a race to the bottom and employers, instead of providing good or very good schemes, will tend to either have their employees join an industry scheme or they’ll develop a master trust concept to just subscribe to and I actually think it might be counterproductive. I appreciate there is a huge number of schemes for the population of the country and there are arguments to be made for reducing that, but I’m not sure that 150 or 100 schemes is the answer either.
McShane: I believe there is a fundamental issue with both the rationale and the data set being used to put forward this argument. The rationale is one of cost – there is a belief that pension schemes are being over-charged for services and that providers are not providing value for money. The data set being used appears to include every retail pension contract in the country. I think the number being used was around 175,000. If you were to strip out the individual contracts from the institutional arrangements I believe it would show that the average management charge paid by schemes to be of the order of 30 basis points for indexed and 70bps for active which is obviously far below the pensions levy being applied by the government in 2014. I believe further work is warranted to determine the true costs to schemes across not only fund management, but also consultancy and admin. Master trust was successful in the Australian market but that was because the market was dominated by a small number of very large industry schemes. That is not the case in Ireland where the market is more diverse and fragmented.
McConville: We’ve had well-documented problems with industry schemes that might also put people off them. Even master trusts here have at times ended up in litigation because there were disputes over interpretation - probably more on the DB than the DC side. This kind of thing appeals to politicians who seem to see it as a panacea, that it is going to offer the most efficient system. But there has to be a recognition that whatever model is put in place has to be focused on providing adequacy at retirement. Simply knocking a couple of basis points off charges is not going to achieve that.
O’Riordan: From a regulator’s point of view it makes perfect sense to have 100 schemes. It streamlines it to some extent, so it has an intuitive attraction from their point of view. Playing the devil’s advocate, the other positive is that we all accept that things have become more complex, governance is getting more stretched so it would seem to make sense that you would have fewer schemes. But the downside here is a figure for the number of schemes gets bandied around, and assumes an authority that really has no basis in fact.
Chair: If you take out one-person arrangements, if you just fix that so one man directors and things will go into contracts that you don’t have to worry about, you do get down to a much smaller number of schemes which are actually much more manageable.
Leech: Usually one member schemes are not the problem, because a lot of them are made up of the person who owns the company anyway. They’re not going to default on paying their own contributions. You can’t ignore them, but just say they’re not in the same category of concern that group schemes should be. I don’t know what view the pensions authority have about this point.
McConville: Another thing is that we might be overtaken by European legislation. If it becomes much easier to sell cross border products, then you might find Ireland is being flooded with low cost DC solutions from the Netherlands or from elsewhere. Any vision of a nice 150 Irish schemes looking after everybody in Ireland is probably unrealistic.
Chair: How does the panel feel about the pensions authority’s pronouncement that governance is at the heart of successful DB scheme management?
O’Riordan: Generally speaking trustee boards of the bigger funds have become like governance boards, with more and more of the functions run through investment sub-committees or whatever it might be. It’s easier for that to happen in the bigger schemes. The bigger issue for most boards of trustees is finding their primary role. If the function is to meet the regulator’s requirements, he is looking at things on an MFS basis. In the pension fund the overriding thing is the actuarial valuation, the ongoing valuation on a going concern basis. Then the sponsor considers things based on IAS19. So you’ve got three moving parts and sometimes there’s a tension between them. There are improvements in the composition and the make-up of trustee boards, but it still doesn’t get us out of the issue – governance to which level, to what standard?
McShane: I would be in strong agreement with this pronouncement, but it’s not always easy to implement for pension schemes. This is why trustees need to outsource expertise to independent providers including investment management, investment consultancy, actuarial and legal, regulatory and compliance. Critical however to outsourcing is independence. Placing all scheme business with one provider is not in my view a ‘best practice’ model and significantly compromises effective scheme governance. Independent voices around the table working in a constructive way to develop the appropriate solution for the scheme would lead to a better outcome. It is now common that trustees, the investment consultant, scheme actuary, sponsoring employer and fund manager meet and discuss potential strategies. Once the desired investment strategy is agreed an implementation plan is put in place. This requires the fund manager and the scheme actuary to work together to implement the strategy. This methodology ensures full independence with each party bringing their particular expertise to the table.
Doyle: More broadly, governance is essentially a structured way of getting good outcomes, and decision-making is a key element of that. The traditional approach of periodic decision making hasn’t really worked. When you’re talking about improving governance you’re effectively assigning responsibility and – importantly – accountability, for each and every decision associated with the scheme. By applying that to all components of the scheme you’re improving governance and getting much greater clarity over who is responsible for what. Overall this dramatically improves your chances of success. It’s true that a good process can sometimes have bad outcomes. But it’s important that you have a process, a repeatable demonstrable process for allocating decision-making, making the decisions in an auditable way almost. Outcomes can work against you, but having that process in place would be an improvement. So to answer the question, I reckon the pension authority’s comments were very constructive and very welcome.
Leech: That’s also a huge protection to the trustees because you could have excellent processes but if the money’s not in the scheme you won’t be able to pay the benefits. Members won’t be very happy and could take cases against trustees as we’ve seen in the recent past. If they follow due process they’re far more protected. There are still a good number of small DB schemes with trustees who are part time and probably more worried about the backlog on their desk in their day job than the half hour they have to spend at the trustee meetings. There are a lot of small defined benefit schemes where trustees, with the best will in the world, don’t appreciate what they’re actually there to do, and I’ve come across this a bit with trustee training. Governance is an excellent thing applied in the proper way with a bit of reasonableness and commonsense thrown in as well.
O’Riordan: Bigger funds have the luxury, if you’d put it that way, of having more resource to throw at it. But a lot of the issues are common, so there must be some way of piggy-backing the expertise that can be brought. Why do big funds keep it to themselves? There must be a way of developing that. I’m not saying this is a service to be sold, just in terms of sharing knowledge.
Chair: Clearly there are lots of issues around DB governance, but is DC governance getting as much attention as it should?
Doyle: Many of the principles associated with governance that apply in DB, certainly around investments and the like, are equally applicable for DC. So much of the heavy lifting around governance models and investment philosophies will still apply. The expertise and advice is available should the trustees elect to seek it.
McConville: In DB governance what you’re looking for if you’re a trustee is good engagement with the employer. You’re saying to the employer ‘this is the professional advice we’ve received, these are the decisions we’re taking’. On the DC side the role of the employer almost falls upon the member. It’s the member who now has to be convinced that these investments are a good idea and be educated as to their viability. Trustees are not investment advisers, but nonetheless they have to instil confidence in the members that they are providing them with a wide range of fund choices that can provide for a wide range of outcomes, and take account of the varying situations in which members now find themselves.
O’Riordan: I’m not a believer in the generalisation that members don’t need to know or don’t want to know what’s happening in their fund. That’s just a bit facile to be honest. Whether they look at it or not is beside the point, but I think it’s a bit patronising to people just to say ‘I won’t give you too much choice because it will only confuse you and if I change the managers underneath then that’s of no concern’. It’s their money!
Chair: How much importance do we place on lifestyling, and are target date funds unsuitable?
Leech: Members are very inert when it comes to pensions, so if you put in a lifestyle as a default I think it behoves trustees to make sure it’s member-tailored rather than just something generic that fits the scheme.
McShane: Lifestyling is now of critical importance for scheme members. Historically, schemes tended to have a default strategy with no lifestyling. Over time, so called lifestyling (into cash and bonds) was introduced, followed by target date funds, which really offered no material advancement on the two offerings that had gone before. Individuals have diverse and very different requirements, genuine lifestyling needs to formulate a holistic view based on these needs. Ultimately a DC scheme is a group of retail investors coming together to gain pricing advantage. However, each member needs to be communicated to in a way that resonates with them and with information that reflects their individual situation.
The IT infrastructure needs to be scalable, adaptable, and robust and reflect the entirety of an individual’s pension assets and if required other assets such as legacy holdings across DB and DC benefits, property and other investments.
Leech: Also, if the longer before the target retirement date that lifestyling kicks in the better, because if I’m forced to retire, say five years before my planned retirement date, that five years is far less significant in a strategy which spans 15 or 20 years than one that spans five or 10 years. It’s very important for people who are paying AVCs, even if they are members of defined benefit schemes. It’s not just for DC members.
Chair: Where people have deferred benefits quite often those get paid at a different time, so somebody might still be working at age 64 but be receiving a pension that started age 60, so the whole concept of what retirement is is changing as well.
On diversification and multi-asset, is that enough? Particularly on the benefits of drawdown management, what are the importance of those? It’s one thing to say to people you don’t have to purchase an annuity, but is what they then do with their money important or do you just say that’s up to people themselves?
Doyle: Multi-asset is a key element of any good investment strategy. To the extent that it includes an investment manager’s best ideas baked in there, such as asset allocation, instrument selection and tactical asset allocation etc, then I think for a DC scheme – and indeed potentially for a DB scheme – it can be a very compelling proposition.
O’Riordan: As a general view on multi asset, we all talk about correlation and real diversification but I wonder what’s the true diversification that’s going on under the bonnet.
McShane: At times of market stress risk assets tend to move in line with one another. Diversification in itself probably doesn’t meet the requirements. The addition of multi asset helps, but schemes tend to have limited exposure to these asset classes as part of an overall effective investment solution. For this reason we would encourage the use of effective drawdown management tools as part of the overall portfolio solution. We are seeing more schemes adopting drawdown management overlays, in addition to diversifying their risk assets.
Doyle: True enough, but it is important to highlight that multi asset gets a lot of unwarranted bad press post-2008 because people say ‘everything went down’. Indeed it did, but equities went down 45 per cent, and corporate bonds went down 2 per cent and to varying degrees commodities, hedge funds, private equity, and everything else went down somewhere in between those. So you definitely wanted to be diversified. It’s not a panacea but it definitely is a very important element of an investment strategy.
Chair: What are the implications of funding level volatility for a sponsor, and the whole idea of solvency trigger point de-risking, when is this suitable?
Doyle: There are tools to limit scheme-specific volatility. Bespoke liability matching portfolios will reduce funding level volatility. So to the extent that sponsors and FDs hate nasty surprises, there are tools available that would significantly help if they were adopted.
McShane: Our approach has been to sit down with the trustees and sponsoring employers to agree a comprehensive and structured approach. The first stage is to determine trustee requirements and preferences around asset allocation, risk appetite and liquidity requirements. We then normally conduct an asset and liability modelling exercise which includes a review of schemes’ current asset holdings and proposals around a more optimised growth and liability matched portfolio. Then we discuss implementation that can take a number of forms based on improvements in scheme solvency – which we can monitor on a daily basis - or based on absolute/relative market/yield triggers. But it is critical that all parties work in partnership – trustees, sponsoring employers, investment managers and advisers.
O’Riordan: It overlays with the whole concept of de-risking, however you want to define de-risking. One of the issues around that is you have the standard of how much is in growth assets or real assets and how much is in monetary. Funds get no benefit from the regulator for switching from, say, long only equities into multi asset funds which purport to be lower volatility. If you did it would improve their attractiveness straightaway, but the regulator only sees long bonds. If there was movement around the definition of the issues I think it would help unlock that.
Doyle: You’ve also got the conundrum of unknown exposures in your overall portfolio which can cause increased volatility. For example, if you’re looking at your asset allocation across the board you might have through your equity manager an exposure to, say, Microsoft. You might have from your bond manager various Microsoft bonds, then through your alternative managers you’ve got a hedge fund with some play on a derivative of Microsoft. Therefore you don’t necessarily know what securities or companies you’re exposed to, unless you’ve got full look through into your entire portfolio and you’re actively managing factors and exposures at an aggregate portfolio level, in order to reduce overall volatility. There are the means to do that now.
McShane: Clearly the shift out of equities and into bonds is a current issue facing schemes. Equity markets have had a very significant run, valuations for schemes have improved and it might be a good time to de-risk but clearly with core bond yields at historically low yields it just does not make sense to allocate to the asset class. We have seen a number of schemes invest in very short term peripheral bonds/enhanced yield products pending a move out in core long dated yields. Most schemes have not proceeded with allocations to long bonds at these levels with many implementing yield trigger approaches for example based on long dated German yields.
O’Riordan: The huge obsession is the real monetary/split. But even within monetary there’s a huge interest rate risk. People really don’t want to buy the long bonds so in terms of their interest rate hedges it’s very, very short unless you employ some of the tactics we’ve been discussing.
Chair: Clearly funding level volatility has quite a big impact. Do you see more that trustees are seeing the sponsor very much as a stakeholder who should be part of that discussion?
McShane: Absolutely Jerry (Moriarty, chair). For the vast majority of the schemes that we work with the sponsoring employer is very much involved on a partnership basis and in a very constructive way. Generally speaking the interactions with the scheme stakeholders are very constructive.
McConville: There are two kinds of structures that you see in pension schemes. In some, the trustees are almost solely responsible for investment management and choice, and in those situations the employer is much more of an observer because it’s not in the position to veto directly. In other schemes the employer has oversight of investment manager choice and perhaps of investment choice. In those situations the employer is actively engaging and needs to because it is taking on a degree of responsibility.
O’Riordan: The only thing is just to be mindful that the trustee has to be seen to have as its primary responsibility the best interests of all the members. Then you need to make decisions on that basis even from a standalone governance point of view.
Leech: Also the trustees looking after the member is good for the employer because the better the outcome, the better for all concerned. A bad outcome can lead to industrial relations issues and all sorts of other problems.
Chair: Some of that discussion brings us on to the legal implications of recent cases – Element Six, Waterford Crystal, and some of that comes down to the employer trustee engagement.
McConville: Dealing with Waterford first, I think the government may well get an adverse judgment. The government effectively tried to pre-empt the judgment by going 50 per cent, possibly because it was 1 per cent more than the 49 per cent that was found to be inadequate. Are the courts going to see that as being sufficient? Maybe they will take a policy view that Ireland just simply cannot afford this and therefore 50 per cent is sufficient, but my guess is that they won’t. Then there is going to have to be a gap to be filled and it’s going to be filled by the pension levy. I think the government sees this as a problem that’s industry wide and they don’t distinguish between DB and DC. My guess is that DC will ultimately be picking up the tab for the solvency of DB schemes.
Chair: There’s so much thrown around about the levy, to be honest I think it’s just filling a hole in the finances. It’s not doing the job it was supposed to. But if they were to start earmarking the money for DB failures, levying DC schemes makes no sense whatsoever. It’s like forcing a person to pay insurance for something they can never claim on. Where that does happen it’s usually called mis-selling.
McConville: On Element Six, I was very closely involved on this so my comments are somewhat coloured. The judge has set out a number of things, firstly that the standard of care required of trustees in Ireland is very, very low. It only requires that trustees be honest and act in good faith. Secondly, trustees are now allowed to take into account various relevant factors, amongst them the threat to their own jobs, the threat to the jobs of those members still in active employment, even if those members are a minority. The judge also supported the view that the trustees must now take care not to imperil the employer’s business or the employment of members within that business. That suggests that employers can now come to the trustees and say ‘we are now going to close up this pension scheme, if you make any attempt to enforce a funding proposal that may or may not be a binding contract, or if you attempt to use the employer covenant to seek further contributions from us we will simply shut this business up’. Ultimately this judgment is very good news for employers because it gives them a window of opportunity to divest themselves of troublesome DB schemes. It’s good for trustees because at least they know now if they make a decision not to pursue the employer it is going to be extremely difficult for the membership to sue them on the grounds of breach of trust. But for the members, particularly deferred members, it’s an unmitigated disaster. What really concerns me is the fact that the public are going to see this and say why should I invest in a pension? Even if it’s a DC pension, will that distinction be made in their minds?
Leech: Were you surprised at the outcome?
McConville: Yes. And certainly our clients were as well. Because we felt that we invited the court to say that the trustees were subject to a higher standard of care. It’s interesting because what has happened is that the judge has effectively said that there is this irreducible core of being honest and acting in good faith and that is it. Beyond that there is no other duty.
Leech: Had it gone the other way would trustees have run scared? Would you have had mass resignations of trustees?
McConville: Had the judgment gone the other way it would not have made a massive difference to the system. It would simply have sent out the message to trustees that if you have a funding proposal that you deem to be enforceable then you should to the extent possible enforce the same. Or at the very least make a contribution demand. It hinges on the covenant because if the covenant isn’t strong then there’s nothing to demand in the first place.
Chair: Any final remarks?
Leech: It’s critically important within the industry that we remain sufficiently up to speed, particularly in the areas in which we specialise but also in a general sense. That goes from the level of the very specialised person – the solicitor or barrister or actuary - to the administrator. If we had more emphasis on that we would get better outcomes, which in turn would help the industry and help ourselves in the longer term. I believe education, both initial and ongoing, within the pensions industry is critical.
Chair: One of the issues that has been raised quite a lot to us by trustees recently is that they have to do trustee training every two years, but the only training the pensions board will confirm meets the appropriateness requirement is the approved training. So basically people who have been trustees for 30 years are sent back to an introduction to trusteeship course. That’s something we’re looking at, as to whether we should introduce some sort of informal CPD requirement.
O’Riordan: I think you need something like a CPD because it forces you to turn up. The industry is getting more complex in a variety of different ways, and we have to keep adjusting, it’s an ongoing process.
Chair: Rounding up, sentiment is clearly better, not just in pensions but in Ireland as a whole and I think that feeds through. There’s still a lot of issues and a lot of issues are going to be around for a while. I’m sure this time next year some of the same issues will be back on the agenda.