Irish Pensions Magazine Spring 2013
16
Our pension system isn’t fit for purpose
by John O’Connell
I
t is very difficult to focus on long-term pension
problems when there are a multitude of short-term
problems that require immediate attention. But this
doesn’t change the fact that we are moving towards
pension provision which is deeply flawed and which
doesn’t reflect long-term corporate, individual and
society needs.
A word about the contracting defined benefit sector
first. Despite the volume of pension legislation and
regulations, the Pensions Act gives practically no
security to members of defined benefit schemes. We
have lengthy regulations dealing for instance with
the content of benefit statements but no overriding
requirement to actually provide the benefits described.
The defined benefit sector has muddled through to the
present on the assumption (or hope) that by-and-large
companies would not abandon the promises of deferred
pay that they made to their employees. This seemed
a reasonable assumption in the past but of course a
combination of weak investment performance, tight
regulation and improved life expectancy have placed
so much pressure on the defined benefit system that a
tipping point has been reached resulting in quite rapid
contraction.
Current regulatory policies make it very difficult to
envisage a future for defined benefit schemes in their
current form. It is impossible to build up sufficient funds
for good retirement benefits on the back of investing
for the long-term in low yielding assets.
We have become used to the defined benefit and
defined contribution labels but how different are they
when we analyse them? It might seem strange in a
magazine for members of the IAPF to look at these
differences but I think it is useful to reflect on the
differences because I wonder if both defined benefit
and defined contribution will end up being stepping
stones to another type of pension provision that may
emerge in the future. There are three key differences:
Defined
benefit
Defined
contribution
Who decides
where the funds
are invested?
Trustees
Member
What is the
primary safety
valve?
Contributions
can be varied
Member’s
retirement
benefits
Is there a
secondary safety
valve?
Wind-up the
scheme
Secondary
safety valve not
needed
Risks that the
member faces
Scheme won’t
deliver
Retirement
benefits
inadequate
Risks that the
employer faces
Uncertain
cost
In the future,
employees will
not want to
leave service
Both defined benefit and defined contribution are risky.
In the case of defined benefit, a member cannot be
sure that they will receive their benefit and as long as
the scheme is operating, the employer faces the risk of
uncertain future contributions, as well as the possibility
of disastrous FRS17/IAS19 accounting returns as has
happened this year. In the case of defined contribution,
the benefits are entirely uncertain.
There is plenty of attention on defined benefit risks
at present – not worth mentioning further here. Some
would say that defined contribution is risk-free because
it will always do ‘exactly what it says on the tin’. There
isn’t a commitment to provide specific benefits so
what’s the problem?
They key difficulty as I see it is that the majority of
defined contribution schemes are likely to provide
pensions which do not adequately replace the salary
which stops on retirement. Previously the standard
response to this largely uncontested fact is “So?”.
I don’t think that this response is going to work in the
future. “So?” means that it’s the individual’s problem
and nobody else’s. Following this logic, if the individual
isn’t happy with a pension on retirement of say 20% of
salary then they can make AVCs.
Most individuals don’t make that choice. If they were
pressed, they would admit that they are underfunding
their retirement and that they aren’t going to address
the underfunding. It’s a long-term problem and it is
impractical to expect people to address long-term
problems when many are under severe short-term
financial pressure.
My feeling is that in the future, this will not be an
individual problem – it will become a corporate and
society problem also. The Government will be drawn
into the mix eventually.
The impact on companies is that individuals will
not want to retire at the normal retirement age and
Analysis
Defined
benefit
Defined
contribution
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