Sunday 10 December 2017

How perfect storm spelled doom for final salary pensions

The past decade has seen the slow decline of defined benefit or final salary pension schemes, where the employer guarantees the pension paid to the former employee.

Now there are clear signs that the trend towards defined contribution pension schemes, where the amount paid to the employee is linked to investment performance, is accelerating.

Last week it was revealed that National Irish Bank, which closed its defined benefit pension scheme to new members in 2008, was transferring the existing members of its defined benefit scheme to a new "hybrid" scheme.

It is the latest high-profile company seeking to cap its escalating pension liability.

Why are employers so desperately seeking to opt out of providing defined benefit pension schemes?

Over the past decade, pension schemes have been hit by the perfect storm of increased life expectancy, falling investment returns and lower interest rates.

According to the latest figures from the CSO, a 65-year- old man could expect to live for another 13.8 years in 1997. By 2007, a 65-year old man could expect to live for another 16.6 years, almost three years longer. Female life expectancy has also increased dramatically over the past decade with the average 65-year-old woman now living for another 19.8 years as against 17.4 years in 1997.

The fact that people are living longer means that employers providing defined benefit pension schemes have to pony up more money to meet this increased liability.


Unfortunately, at the very same time, investment returns were collapsing. The average Irish managed pension fund has been essentially flat over the past ten years. In other words, €1,000 invested a decade ago would still be worth just €1,000.

Compounding these problems has been the collapse in international bond yields. Under Irish pension law, an employer must buy an annuity for a retiring member of a defined benefit pension scheme. An annuity, usually provided by a life assurance company, guarantees the pensioner a fixed income for the rest of their life. Annuity rates are linked to bond yields. Unfortunately, with the yields on 10-year German government bonds now down to just 2.4pc, buying annuities has become prohibitively expensive for employers.

In a desperate attempt to save the remaining defined benefit pension schemes, three-quarters of which are in the red, employers' group IBEC and the Irish Congress of Trade Unions have combined to call on the Pensions Board to relax its funding requirement.

If IBEC and ICTU get their way, the future liabilities of Irish pension funds would be valued on the basis of Irish government bond yields, which are currently at almost 7pc, rather than German bond yields.

Even if the Pensions Board agrees to the request, it will do no more than buy time for the remaining defined benefit pension schemes. The future for Peter and other members of such schemes is one of increased contributions and reduced benefits.

Last week, it was revealed that AIB will need €3bn more fresh capital than had been estimated by the Financial Regulator last March. The vast bulk of this extra capital will come from the Government, meaning that the State will end up owning somewhere between 70pc and 90pc of AIB.

The de facto nationalisation of AIB means that, in addition to the existing Government deposit guarantee, Lorna's deposit also carries an implicit State guarantee. This makes Lorna's deposit even safer than it was last week.

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