Say goodbye to your future, grandpa
As pension schemes run aground, sovereign annuities become the option of last resort
THE dog-eared contents of the envelope spilled across the desk together with the scratchy 60-year-old handwriting, “Dear Eddie, I thought pensions were guaranteed? What have they done to my thirty thousand pension after loyal service since the 1970s?”
The question really should have been, am I a pension holder or a bondholder? Dilbert, the American satirical cartoon by Scott Adams, on May 12, 2009, probably best explained sovereign annuities — three years before they hit the streets:
Wally: “I've decided to dabble in crime. I need some henchmen. Are you in?”
Asok: “What does a henchmen do?”
Wally: “A henchman's job is to be gunned down in reverse order to his importance.”
Asok: “How important am I?”
Wally: “I wouldn't pack a lunch for orientation day.”
Personal sovereign annuities are last-resort pensions where the pension holder is repositioned by the trustees of a deeply troubled occupational pension scheme, as a bondholder. That means market default risk is not shock- absorbed by the scheme but passed straight through by a life office to which the trustees have abdicated responsibility, arguably because they’d little choice left. If a default event occurs to any of the bonds the cash could disappear permanently.
The envelope contained the policy document together with sheets of tiny print detailing how the flat monthly income was derived from five different bonds — that’s over 430 payments to 2049. But what caused the alarm was Example 2 – Full Default.
“Assume that all of the reference securities cease payment, with effect from January 20, 2015. We continue to make full payments for three months. . . From May 2015 onwards, payments reduce to zero. Payments resume in January 2049, because the payments are not linked to the reference bonds beyond that date.”
No wonder he couldn’t sleep — worst-case scenario, not a cent for over three decades and by age 96, the flat pension of €30,000 would have lost two-thirds of its
purchasing power with inflation running 3 per cent on average.
Occupational pension schemes have been running aground ever since we’ve started to live longer, jacking up the pension debt owed to members beyond the combined ability of many employers and employees to fund. The response, well under way before the Lehmann heart attack moment in 2008, were counter measures worldwide as guaranteed pension schemes started to close down to new workers or to radically restructure benefits to trim back the pace of accelerating debts which quickens in velocity as a workforce ages and salaries rise.
The collapse in share values, the principle vehicle relied upon to diminish employer contributions was accompanied by the double whammy of a collapse in the market value of some eurozone Government bonds and a flight to German bunds which caused them to become extremely expensive — that meant needing nearly 600 times the monthly pension, in capital, to secure them with bunds.
Meanwhile, back at the ranch, Irish defined benefit schemes were in meltdown because solvency tests linked mounting debts to German pricing — but with Irish bond yields gone in the polar opposite direction to German bunds, the pension industry sniffed an opportunity — when in trouble, change the rules. The industry asked for debts to be recalculated using much cheaper Government Bonds — lowering the liabilities on their accounts by using riskier bonds. But where schemes were really in the crapper, the trustees could wash their hands entirely — in the industry vernacular “discharge the liability” to life offices.
Three stepped forward from December 2012, Irish Life, Zurich Life and New Ireland each giving trustees, sovereign bonds based on a range of stripped-down Irish Government bonds especially created by the National Treasury Management Agency for them. Under pensions law, the trustees of a scheme may, at any time, notwithstanding anything contained in the rules of the scheme act without the consent of the members. Trustees are also quite explicitly protected from breach of trust — provided they acted honestly and reasonably.
All three sovereign bond offerings so far are based on Irish bonds but to comply with EU rules, any sovereign bond in the eurozone can be used in applications to the Pensions Board. Irish bond yields have fallen so dramatically that they no longer offer the same attractions — so inevitably, eyes will turn towards riskier high-yield bonds from elsewhere in the eurozone.
What we may be witnessing is a fundamental change in the nature of pensions, so should we be comforted by deep-dive investigation, analysis and pre-screening? The Pensions Board, which has an FAQ for trustees and life offices but none for consumers, would appear to have taken its guidance from the 5th Prefect of the Roman province of Judea AD 26-36;
the reference bonds underlying sovereign annuities. In summary, certification of the sovereign annuity policy by The Pensions Board, should not be construed as an approval or otherwise of the appropriateness of any individual policy.”
Evidently the Regulator, much like Pontius Pilate isn’t too convinced about what the high priests of the industry want and is concerned about reputational damage to pensions in general if the worst case scenario unfolds — that’s a recycling of the eurozone crisis leading to minor or major default events on government bonds that underpin sovereign annuities.
There’s little chance of that just now, but the 60-year-old carries the risk on a one-way ticket until 2049, having been switched from a guaranteed pension holder to a bond holder and now trapped right on the fault line of the eurozone’s economic and political experiment in existential crisis management.
In the meantime, the pension income itself, which initially was to have been inflation-protected, is guaranteed to lose value each year to general price increases. By age 70 at just 3 per cent inflation, the flat €30,000 pension will buy a little over €22,000 in goods and services and shed nearly half its purchasing power by age 80.
No matter how you excuse it as an escape route from upside-down pension schemes, sovereign annuities that pass the risk through to pensioners are potential weapons of financial destruction, little understood by elderly pensioners and inadequately explained to them by the Pensions Board or their creators – few of whom are ever likely have to rely on one.