PwC have published their report on the 2009 Pension Survey of over 400 Irish employers which was carried out in July 2009.
The 2009 PricewaterhouseCoopers Pension Survey was conducted against a most challenging backdrop for Irish private pension schemes. The average managed pension fund fell 35% in 2008 resulting in significant deficits emerging in defined benefit pension schemes and members of defined contribution schemes seeing their investments fall significantly year-on-year.
The purpose of the survey was to provide an up-to-the-minute analysis of the steps being taken by and being contemplated by Employers to deal with the challenges that this backdrop presents, and reflecting the economic environment which currently pervades in Ireland.
250 employers who offer defined contribution pension schemes to their staff responded - and an outline of the key findings of the survey are outlined below.
Contribution rates into defined contribution schemes remain stubbornly low - certainly too low to provide an income that many would regard as adequate in retirement. The majority of Employers providing defined contribution schemes are paying contributions of between 4% and 7% of salary, a figure that is unchanged from previous surveys. The pension expectations of employees who receive this level of benefit are not likely to be met.
The level of contributions vary across industries, with Financial Services faring better, and Manufacturing and Construction sectors faring relatively worse than average.
Reflecting the current challenging economic backdrop, almost 10% of employers are considering or actively implementing a reduction in contributions that they make to defined contribution pension schemes. This reflects what is being seen on the ground - faced with the choice of reducing staff numbers, or cutting salaries, a reduction in pension contributions may be seen as a "good" result, in that the impact is not immediately felt. Further, there are suggestions that the tax efficiency of pension arrangements for higher earners will be reduced on foot of recommendations of the Commission on Taxation, meaning that the imperative to provide a generous (or even any) pension scheme to reward higher earners may be reduced.
Taking the points above in aggregate, there is no visible sign of Employer contributions to defined contribution schemes being adequate in isolation to meet the retirement needs of most of the employees who participate in these schemes, and the trends are towards lower and suspended contributions looking forward.
The survey also highlights how investment losses have impacted behaviour of members of defined contribution scheme. The survey found that 30% of employees are seeking to reduce their exposure to equities. At present, almost all defined contribution schemes operate on the basis of a "best efforts" approach - investment choices are provided which typically offer the highest expected returns in the longer term. What we are seeing is the practical difficulty with such an approach. Many contributors to defined contribution schemes do not have high levels of financial understanding in respect of investment market movements and are finding the levels of investment loss experienced to be unacceptable. As such they are opting out - whether by reducing their exposure to risk assets, or by reducing their personal contributions payable. The survey highlights that one-third of members are looking to reduce pension contributions that they personally pay, a reaction to investment losses and the lower levels of income and job security that currently exist.
More positively, there is evidence of a reaction to the events of 2008, suggesting that lessons have been learned. The survey indicates a widespread review of investment strategies being adopted within defined contribution schemes, including in particular a review of the default investment strategy (which is available for members who do not feel comfortable in making an investment decision themselves). Almost 70% of respondents are reviewing their investment strategy and in particular their default fund - and it is likely that more risk aware strategies, reflecting member's perception of investment risk, will emerge in the future.
150 employers who sponsor defined benefit schemes responded - some of whom will sponsor more than one defined benefit pension scheme.
5% of employers identify that they are going to wind-up their defined benefit pension scheme, with a further 15% of employers identifying that this option is being considered. Winding-up and moving to a defined contribution design has a clear attraction, in that all investment and longevity risk can be passed to employees. The survey results indicate that average Employer funding being provided to defined contribution schemes is typically around 5-6%, meaning that pension outcomes for affected employees will likely be significantly worse in the future.
Changes to legislation have been introduced such that the Pensions Board can now direct that both deferred and active members' benefits, as well as pension increases, can be reduced where in the opinion of the scheme's actuary this is required, so that the scheme will meet the funding standard following the reduction. Over 40% of respondents have identified that this option will be considered. The number is startlingly high, given that a reduction in benefits is a serious loss for scheme members and the Pensions Board will consent to an application to reduce benefits only where it is satisfied that the long term sustainability and stability of the amended scheme can be reasonable assured. Equally, the level of appetite for such an option does indicate the extent of the challenges which Employers face.
Members in defined benefit pension schemes are likely to have to make higher contributions going forward. The survey results indicate that current contributions for members range from 0% through to 10%+, with the average contribution required being of the order of 5-6%. A third of employers have decided to increase member contributions further, and a further third are considering this as an option. Members of defined benefit pension schemes have been faced with a higher taxation burden as a result of the introduction of income and health levies in recent budgets, as well as pressures on salary levels generally due to the economic conditions - and the survey results indicate that there is more pain to come. Further, the Commission on Taxation is due to report later this year, and one mooted suggestion is that a hybrid rate of tax would apply to personal pension contributions - which would negatively impact higher earners who are required to make high levels of pension contributions related to their membership of a defined benefit scheme.
The investment market turmoil of 2008 does appear to have left a legacy - over 70% of employers are actively considering reducing the investment risks within their defined benefit scheme. Pension investment losses in Ireland in 2008 were the worse than in almost all other economies because of the large share of equities in pension-fund portfolios: around two-thirds of assets were equity invested before the crisis hit, compared with an average equity weighting of 36% in the 20 comparison countries where data was available. Employers are identifying that the pension arrangements that they sponsor carries a material business risk, and they are looking to manage this risk as they do elsewhere in their business. Reducing the reliance on equity markets is part of this strategy.
Employers are seeking out a range of funding options. 20%+ of employers are considering non-cash funding options, with a view to discussing these with Trustees. This reflects the increase in broad business thinking being brought to the table to solve the pension issues which are arising. Non-cash based solutions can enable a compromise to be reached between the security sought by trustees and the level of cash contributions that is feasible for the business. Such structures can provide security for pension schemes in the short term while allowing extended periods to allow the pension scheme deficit to be repaired. The extended periods for deficit funding mean that short term cash contributions are minimised.
The survey highlights other steps that employers are looking to implement. One third of employers will or may stop their employees earning benefits within the defined benefit scheme - and two thirds have closed their scheme to new entrants.
The survey also highlighted what funding plans employers are considering. 10% of employers responded that at present the funding plan is unclear due to the level of the deficit and the ability of that employer to pay; a further 20% of employers are going to seek funding periods of over 10 years. Again, the figures are stark - potentially 30% of employers do not have the ability to fund their pension deficits over even the medium term.
Defined benefit schemes do not of course operate in a vacuum. Their long term health is contingent on the support of a viable employer, with the ability and willingness to make the necessary pension contributions. Underfunded defined benefit pension schemes will need higher levels of cash contributions just when Employers are seeking to preserve cash by all means necessary. Trustees are under pressure to secure cash contributions from Employers to repair the significant deficits which have emerged - while cash-strapped Employers are finding contribution levels being demanded difficult to afford. The survey explores these issues also.
At a high level, the views of employers who sponsor defined benefit schemes are understandable and relatively consistent across the board:
- current economic conditions are of real concern to employers
- employers are under pressure to develop a plan to correct pension scheme deficits - but they need the flexibility to allow them to cope with the economic downturn and the wider impacts that this will have on their business
- employer dialogue with trustees is increasing, with a view to communicating what is reasonably affordable for the employer - quite simply, many Employers cannot readily afford what Trustees are likely to require
- employers are seeking independent advice reflecting that their objectives differ from those of Trustees. They are looking to explore the limits of what is permitted, to defer or minimise increases in cash contributions and to identify non-cash alternatives that may be more acceptable to their business at the current point in the economic cycle.
Notes
1. Pension systems in 30 countries were surveyed by the OECD in their "Pensions at a Glance 2009" report, which identified that investment losses in Irish pension arrangements were the worst of the countries surveyed.
2. Recent commentary by the Pensions Board suggests that 90% of defined benefit schemes could not meet all of their liabilities were they to wind up at present.
3. The Pensions Board offered extensions to the period within which a funding proposal (a plan to fund deficits arising, required where a defined benefit scheme is insolvent) is required to be submitted. For many schemes 31 December 2009 is a 'deadline' date with respect to extensions offered.