Ireland's pensions industry is struggling under a deluge of legislative changes and economic difficulties. Chris Panteli discovers the effect that this will have on de-risking
New regulations forcing liability-hit defined benefit plans to be more transparent about their deficits are set to create a fundamental shift in the Irish de-risking market. Pension associations have called for the creation of new, longer-dated government bonds which they claim will match their liabilities, while simultaneously helping the government deal with its own funding problems. Meanwhile, others predict the bulk annuities market – already hugely popular in the UK – will find rich pickings in the emerald isle.
The regulations have come about because Irish pension funds, like their counterparts across the world, are facing difficulties. Three out of four defined benefit schemes in the private sector are in deficit and from 30 November, those schemes in difficulty must start to inform the Pensions Board how they propose to reduce their funding deficit and how quickly.
The deadline had originally been set for May 2011, but last month the Department of Social Protection announced this would be extended, although it has yet to set a new date.
The government has also agreed to bring forward its proposal for a “new” DB model as set out in the National Pensions Framework (NPF). The NPF was announced in March and, recognising the difficulties facing DB schemes, proposed an alternative approach to scheme design for DB schemes facing restructuring due to increasing levels of insolvency, liability escalation and poor investment performance.
This new design would provisionally include fixed contribution rates for workers and employers and guaranteed core benefits, with non core benefits flexible and dependent on economic conditions. Although the promised level of benefits would be significantly lower than under a typical DB scheme, they would provide a greater degree of certainty
Although the NPF has been set up to improve the security of Ireland’s DB schemes, some believe the new funding requirements have not come at a good time for employers.
“The funding situation at the moment is quite difficult for a lot of schemes, particularly because a lot of funding proposals now have to be submitted from November,” said Aon Hewitt director of actuarial consulting in Ireland, Kathy Murphy.
“Given the condition of bond markets the main issue is whether it is appropriate now to dive into bonds. They are probably the most expensive they’ve been in ages if you look at more secure sovereign debt. And given there has been so much issue recently the outlook for returns on that is a little uncertain.”
The issue with bond yields is a serious one that goes beyond asset allocation. Irish pension funds calculate their liabilities using the market annuity price as if in a wind-up. These annuities are largely priced off German and French government debt, which have seen yields plummet over the last few months. Annuity prices in Ireland have rocketed by between 10% and 15% as a direct result, causing huge problems for struggling schemes.
It is against this backdrop that the Irish Association of Pension Funds (IAPF) and the Society of Actuaries in Ireland (SAI) proposed the launch of a “sovereign annuity”, which would be priced off Irish government bonds.
This, the two groups claim, would bring about an immediate reduction in scheme liabilities, but the move requires government backing and the issuance of new, longer duration bonds.
To support this new market, the proposal suggests the National Treasury Management Agency would, on behalf of the Exchequer, issue a supply of bonds of appropriate average duration (12 to 15 years), ideally in coupon-only form.
“One of the reasons Irish annuity providers don’t use Irish bonds is because the duration generally isn’t long enough,” said IAPF director of policy Jerry Moriarty.
“To a large extent the government issues a maximum 10 year bond and don’t do index linking. There are a lot of features that don’t make Irish bonds in their current format compatible with pensioner liabilities, because they are expecting to be paid them for a significantly longer time.”
Supporting changes in pensions legislation would also be required. The minimum funding standard would have to be amended to explicitly allow sovereign annuities as an acceptable measure of a scheme’s solvency. Also, an amendment would be required over-riding existing scheme provisions so buying a sovereign annuity would be a permissible way of discharging a trustee’s obligations.
“For annuity providers to justify doing this, there would also be a requirement that they would be allowed to reduce the annuity if the bond wasn’t repaid or if there was a default,” Moriarty added. “That is an issue in terms of the appetite for doing something like this.”
The IAPF and SAI have yet to receive a formal response from the government, but speaking at the Annual Benefits Conference of the IAPF last month, Minister for Social Protection Éamon Ó Cuív TD confirmed his department is giving “serious consideration” to the proposal.
While on the face of it the proposal appears like the ideal solution for both schemes and a cash-strapped government, some believe the idea will not be successful in the short term. Aon Hewitt’s Murphy remains unconvinced of the government’s desire to push through the necessary legislation required when its economic strength is so fragile.
“I don’t think the sovereign annuity plan is a realistic prospect, certainly not in the short term,” said Murphy. “There would have to be some provision in there that in the unlikely event the risk of deferral or default on the debt you would have to reduce pensions and I don’t think that’s something the government want to put into legislation right now.
“The differential goes away if our credit rating improves so to that extent. the longer they take to do it and if the credit rating improves, it is not going to have as big an impact. However, if the government needs funding and pension plans are looking for long term investments it would solve everybody’s problems.”
Moriarty however is confident that the sovereign annuity could easily and effectively help solve the problems of both pension funds and the deficit-ridden government. “I’m not sure this would require a whole amount of work,” he added. “It requires issuing debt in a slightly different format than they are currently using, but it does open up a new buyer effectively, and a buyer with a very specific purpose. In that way it’s a kind of win-win situation.”
Indeed, research by economist Brian Devine at stockbrokers NCB said demand for Irish government bonds could be boosted by as much as €10bn if the sovereign annuity is given the green light.
“It is difficult to derive a final demand figure, but we feel that if this proposal is brought forward, benchmarks are changed and legislation is altered that it could lead to a shift into Irish government bonds over a two year period of approximately €7-€10bn on the view also that DB pension funds increase their fixed income exposure as seen in the UK more recently,” said Devine in a market note.
“To put this in context, we estimate that 2011 and 2012’s funding requirement will be in the order of €25bn each year (these borrowing figures will change when the four year budget is outlined in November).”
Some observers also believe many schemes will start looking at wind-up and bulk annuities for the first time as a result of the funding proposals.
“We will probably see more schemes looking to wind-up and then buy out pensions and pay transfer values for active and deferred members,” said Murphy. “We will see a lot of changes to benefits but with that there are a lot of schemes looking to de-risk either partially or almost fully, particularly when they are cutting back on accrued benefits.
“There is no debt on the employer here but in most cases employers are actually funding the deficit now. It’s not like in the UK where they fund a buyout; they fund a transfer value which is nowhere near buyout.”
The bulk annuity market in Ireland is currently relatively small, partly because the number of schemes is relatively small – thousands rather than the tens of thousands found in the UK – while their value in assets also tends to be lower.
However, the recent changes in legislation have led UK bulk annuity provider MetLife Assurance to set up shop in Ireland in the belief that de-risking is steadily creeping up the priority ladder.
Research carried out by the firm found the majority of financial directors (FD) believed de-risking their pension scheme was important to achieving the overall business objectives. While the overall results were fairly comparable with a similar study in the UK (63% of FDs considered it to be important in the UK compared with 76% in Ireland), those who considered it to be “very important” differed more widely, with 16% of FDs in the UK compared with 32% in Ireland.
“There is an opportunity in Ireland that has only recently come about,” said MetLife head of business development Emma Watkins.
“Schemes now have to prepare funding statements, they’ve been hit by the recent volatility and it is possible that as a result of that, based on what pension trustees and advisers are talking about, that de-risking will go up the agenda for FDs and trustees alike. If you then consider the differences in legislation between the UK and Ireland, it also makes us believe it is possible more pension scheme buyouts will happen.”
Debt on the employer legislation does not exist in Ireland, which means if a company was to walk away from its deficit-hit pension obligations it can reduce benefits in keeping with the assets the fund contains.
“The barriers you have seen here in the UK in terms of schemes not being fully-funded and employers not being able to meet the debt on employer do not exist in Ireland,” said Watkins. “They can reduce the benefits and use the benefits the scheme has.”
“Although it is a small environment in terms of size the legislation leads to a greater number of transactions happening because you don’t have to fill that gap in funding.”
There are many things for Irish pension fund trustees and sponsors to be worried about at present, but for every problem facing them there appears to be new and innovative solutions being put forward.
If the government’s NPF becomes established, the IAPF and SAI’s sovereign annuity proposals are accepted and the bulk annuity market grows larger, more competitive and more willing to deal with smaller schemes, the country’s pensions industry could ride out the storm stronger and healthier than it entered.
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