Saturday 20 January 2018

Funds have been hit hard by plummeting stock markets

Charlie Weston

TRADITIONALLY, with a defined benefit (DB) pension an employer promises to pay someone with 40 years' service two-thirds of their final salary.

Employers used to promise to make up any shortfall in a pension. But the fact that people are living longer has made it more expensive to fund pensions.

Dreadful stock market returns and low interest rates have also hit funds.

With the proposed new arrangements, workers are likely to have to accept a lower guaranteed level of pension, with other elements of their retirement funding made up of riskier defined contribution-type arrangements.

With a defined contribution (DC) pension, the employee takes the risk that the investments will not make sufficient returns to give them the level of pension they expect.

One of the proposals to help DB pensions involves allowing funds to benefit from the economy's chief woe -- the high cost of government borrowing.

At the moment, DB funds have to demonstrate that they have sufficient funds to pay out pensions if they were to close the next day.

An immediate closure would mean taking the funds left in a scheme and buying an annuity.

An annuity is a contract sold by an insurance company, like Irish Life, designed to provide guaranteed payments at regular intervals.

For example, suppose a pension fund is forced to close and it has been calculated there is €100,000 to buy one of the workers an annuity. The pension fund administrators would go to Irish Life to buy an annuity.

In turn, Irish Life would put the money into German bonds, as this is regarded as safe. But German bonds offer very low returns -- currently 2.2pc.

In contrast, the Irish State is having to pay more than 6pc on bonds to borrow money from international lenders.

The problem is that a life company will only be persuaded to invest in Irish bonds to provide an annuity if new legislation is brought in allowing it to break out of a guarantee payment from the annuity in the event of the Irish State defaulting.

In other words, it would have to be written into legislation that pension benefits could be lowered if Ireland was forced to tell bondholders it could not pay them what it had borrowed, and was forced to pay out, say, €7 for every €10 borrowed.

Naturally, the Government is anxious not to countenance a default and is especially keen to avoid mentioning the word default in legislation.

Irish Independent

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