Exploding pensions
John Feely, Head of Strategic Development at Abbey National Wealth Management and Long Term Savings Division, and Chairman of the Irish Association of Pension Funds, spoke recently to the ACCA Ireland Financial Services Network on “Exploding Pensions”. Niall Duggan reports for the benefit of members who were unable to attend.
Mr Feely identified six key issues in pensions: the move away from Defined Benefit (DB) schemes, the adequacy of Defined Contribution (DC) schemes and the expectations of members, the need to simplify pension products, corporate governance of pensions, funding and investment returns.
From DB to DC
The move from DB to DC schemes is being driven by the rising and potentially
unlimited cost of pensions being faced by employers. With investment returns
falling, earlier retirement and longer life expectancy, the funding cost of
pensions has increased. The advent of FRS 17 and IAS 19 (revised) has brought
greater transparency to pension costs and balance sheet risk. There is a clear
need to inform and educate pension fund members about these issues. More importantly,
it must be asked whether the move from DB to DC is the right answer to the current
difficulties.
The current DC contribution rate is too low to provide the pension that a member may be expecting – DC contribution rates are only about half that required under DB schemes to meet pension expectations. Accordingly, DC members will have to work longer, increase their contribution rate or find supplemental income if they wish to retire to the lifestyle and income they expect but are not guaranteed to receive under DB schemes. The provision of regular statements of reasonable projection – setting out expected pension benefits – would keep scheme members informed. Scheme objectives should be reviewed and modified regularly.
Setting a compulsory DC scheme contribution rate could mean that members will do no more than comply with this lowest common denominator, meaning that the needs of some members will not be met.
Pension simplification
Mr Feely would welcome the simplification of pensions in a number of respects.
Pension regulation has evolved on a piecemeal basis, most recently in the form
of the personal retirement savings accounts. Alternative means of consumer protection
should be explored to see if a more economic and suitable form of regulation
can be put in place. The move to DC schemes imposes increased regulatory costs,
which are probably not economic for small schemes.
Poor investment performance
The recent investment performance of pension funds has been very poor, after
three years of falling equity markets. With faith in the equity culture dented,
funds are facing big decisions. Some assumptions have to be made by trustees
and their advisers: that the markets will stabilise and return to growth (albeit
at more modest levels), that there will be longer life expectancy and so people
will need greater pension provision and/or to retire later, and that trustees
will be more informed about their fund’s strategy, investment assumptions
and their members’ expectations.
The importance of equity investment will vary by scheme type. DB schemes can be expected to invest at least 55% of their assets in equities as trustees will take a more balanced view of life. DC schemes by their very nature will be more conservative as members take the full investment risk and a lower equity exposure can be expected. The DC contribution rate and the adequacy of the fund to provide the expected retirement income are key issues that need ongoing attention.
In conclusion, Mr Feely stated that the recent difficulties faced by pension funds had underlined the need for greater communication between trustees, advisers and members. This would allow scheme members to assess the adequacy of their pension provision and to develop reasonable expectations that could be met.
Niall Duggan – Bank of Scotland Ireland Limited