Pensions, particularly of the gold-plated variety, have received elaborate coverage this past week. The furore over excessively generous pensions for politicians has been accompanied by revelations that the taxpayer bailout for AIB has resulted in a massive transfer to that company's (previously underfunded) pension scheme.
The result will be an enhanced ability for AIB to pay out enormous pensions to former executives, many of whom can reasonably be held responsible for the company's insolvency, unless you believe it was an act of God.
There is a 'legacy' feature to the estimates of cost for the pensions payable to politicians. Those who were elected more recently will not benefit from the prior over-generous scheme, which was modified significantly by the previous government. But many serving politicians, including ministers, are entitled to remarkably generous pensions, as are numerous senior public officials, including judges.
Few private-sector employees, even top managers, could hope to accumulate pension entitlements comparable to what some politicians and officials are due to receive.
There are three problems with the existing public-service pension system. The first is that it is utterly opaque: it is just too difficult to see what is going on. The second is that it is (almost entirely) unfunded -- no funds are set aside each year to provide for the benefits. The third is that the benefits in many cases are simply too generous.
Pension schemes of the so-called 'defined-benefit' variety offer to pay pre-specified amounts on retirement, usually a percentage of final salary, as long as the retiree survives. The sponsoring employer is deemed liable to meet this obligation. In private companies and in the State commercial sector, a collective fund is established and both employer and employee make regular cash contributions. The individual does not 'own' directly the funds contributed; there is instead a claim on the collective fund.
If pensioners live longer, if investment returns are poor or if benefits have been promised which are excessive relative to cash contributions, the collective fund can go into deficit. If, in addition, the firm gets into trouble, there is nobody to backstop the fund.
In Ireland, people are living longer, investment returns have been poor and neither employers nor employees have been keen to pony up more cash. As a result, most of the funded defined-benefit schemes are in deficit.
The problem is particularly serious when firms face insolvency, as the banks did prior to the €64bn bailout. Under existing rules, those who have already retired get absolute priority if a collective fund has to be wound up and employees still working can face sharply reduced pay-outs. Some workers approaching retirement age have had a double-whammy: redundancy, plus a serious reduction in pension expectations.
Most private-sector firms no longer offer defined-benefit pensions. They have moved over to so-called defined-contribution schemes, where the funds accumulated belong unambiguously to each individual employee. This individualisation of pensions means that employees no longer have an entitlement to, for example, a pension related to final salary, but rather will receive benefits dependant on the performance of the investments. But they are no longer exposed to the solvency of the scheme since it is no longer collective. Importantly, their pension pots are also not exposed to the insolvency of the company.
Defined-benefit schemes are strewn with temptation. The biggest temptations are to make unrealistic assumptions about investment returns and to negotiate fancy benefits unsupported by adequate contributions. Because the schemes are meant to last forever and will typically have enough cash to meet current payments to retirees, they can turn into Ponzi schemes where current contributions are eaten up, making these payments and the schemes become insolvent. Private companies competing in today's markets are not credible guarantors of long-term pension-fund liabilities. The defined-benefit model is broken and the individualisation of pension savings is the unavoidable alternative.
In the public service, no funds are invested and the collective obligation falls on future generations of taxpayers, rather than on the unretired employees. The 'pension contribution' imposed on public servants by the last Government would more honestly have been described as a pay cut for this reason.
Over-generous pensions derive principally from accelerated accumulation of entitlements through options for early retirement on full pay (gardai, Army) or rules which say that, in effect, you do not need 40 years of service, 20 or even fewer will do fine (judiciary, politicians).
In some cases, it has been calculated that the annual provision that should be accrued for future pension payments can be almost as much as actual salary. In other words, some folks are costing almost double the apparent salary level.
AIB is now owned by the State. Its board announced recently that it had transferred the enormous sum of €1.1bn to the company's defined-benefit pension scheme. This scheme, in common with many others, had become seriously underfunded.
When the Government injected €20bn into AIB, the intention was to replace the lost equity capital and to provide for the enormous losses on property-related lending.
Without recapitalisation, AIB would have had to close its doors. In those circumstances, the pension fund would have gone the way of the fund at Waterford Glass, where the company went down despite several shareholder recapitalisations. The pension fund did not have enough funds to meet all obligations and the unretired members lost heavily, since retired members get preference under Irish law.
To be clear about this, AIB employees would not have received the pensions they had been expecting because the company had gone bust and would have been unable to produce funds to meet the deficiency.
AIB employees must feel relieved that the company will now be able to fund their pensions. It would have been a horrendous outcome had they lost not just their jobs but also the pensions to which they have contributed.
However, there are thousands of workers throughout the country in the same boat, who were unfortunate enough to have chosen employment with insolvent companies that did not happen to be banks. These employees and their trade unions will argue that a precedent has been set.
The State, needless to say, is in no position to step in and make up for deficiencies in defined-benefit pension schemes, being itself bust, reliant on borrowing from the EU and the IMF and saddled with enormous unfunded pension obligations of its own.
When the Government bailed out AIB, it made the company solvent again. The board must have felt that it had little option as a solvent company other than to make up the deficiency in the pension scheme. But has there been a negotiation with employees about increased contributions and reductions in benefits? Has the scheme been closed to new members?
An unintended consequence that has predictably attracted caustic comment is that former senior managers at AIB are now enjoying pensions of up to €500,000 per annum courtesy of the taxpayer.
Even the normally reserved Financial Times was moved to barely concealed fury at the thought. Arguing that these super pension pots were built up from bonuses based on fake profits, it argued that the managers should volunteer to surrender a portion.
It said: "While a pension cut may not be enough to salvage their honour, failure to act will guarantee their status as pariahs."
Of course, AIB is not the only bank that was bailed out and there were pension-fund deficits in others, including Bank of Ireland. Michael Fingleton, whose Irish Nationwide managed to lose an even bigger percentage of its loan book than Anglo, walked away with a pension fund of €27m.
Deputies Olivia Mitchell and Roisin Shortall both called during the week for a root-and-branch review of the Irish pension system, which is riddled with anomolies. It is time to end the collectivisation of pensions and move to an individualised arrangement, where the contributor owns the money unambiguously.
In the public service, pensions should be pre-funded and future employees should be invited to join defined-contribution schemes on the same terms as their private-sector colleagues. There needs to be a realistic cap on tax-relieved contributions and there should be no vesting of bonuses -- and consequently no accumulation of banker pension entitlements -- until sufficient time has passed to see if the profits are real.