Pension liability crisis is the real 'time bomb'
"The Pension Crisis", "The Ticking Pensions Time Bomb" - both phrases have been bandied about in the public domain over the last few years to, in some way, address and describe the myriad of problems faced by Ireland's pension sector. But these terms are too vague and all-encompassing to have any real impact.
We need to take a more polarised view of the issues impacting the sector. We must segment the pension sector and assess each element individually - because each is so different in its operation and offering and each requires a wholly different solution.
Without a doubt, the Defined Benefit (DB) liability crisis is significantly graver than the asset crisis that preceded it. It has also been under-hyped and undersold, at least until now.
Public and private sector comparisons have dominated pension debate and much less attention has been given to the fact that DB schemes in Ireland are in a much deeper crisis then they were during the Recession, when funding was the primary issue.
Many members of these schemes are not sufficiently aware of the reality of the situation.
Members have the simplistic yet understandable view that because they, and their employers, have paid their contributions into the pension plan over many years there should and will not be an issue when it comes to collect.
What is missing is the understanding that a major proportion of the DB pension promise is built on the contribution that the capital markets also make over the years to the fund. Without consistent returns from the markets, trustees struggle to make the model work - and that is the situation we are faced with today.
Low yields and low discount rates, leading to very high and increasing deficits, mean that the promises made by DB schemes need to be re-evaluated in many cases.
The regulatory rules that manage the solvency of schemes work on the premise that schemes must in theory, be able to pay out all benefits today, rather than solely focus on their ability to pay out promised benefits over the next 30-60 years.
So, let's put this in context - if a first-time-buyer was to be assessed for a €300,000 mortgage application using the same regulatory rules, they would not only need to prove that they could meet the monthly repayments, but have €300,000 in a savings account as well. That's not workable in the real world. Neither is the current method of regulating future pension liabilities.
Looking back to 2008-2009, it was very clear that to everyone that we had an asset crisis; it was very visible and tangible. The global fix that was found at the time, quantitative easing (QE), was not invented to solve the problems of pension funds.
In fact, pension funds have suffered enormous collateral damage as a result of QE.
The market recovery in the last few years has seen asset values recover, but not yields. We now have very low yields, very low discount rates and very high levels of deficits at many pension funds.
In contrast to the asset crisis of 2008-2009, we now have a much larger liability crisis as the capital sums needed to deliver the same level pension promises are significantly increased.
In 2008-2009, the responses from pension funds, trustees, employers and trade unions was to add significant single and ongoing contributions, re-negotiate and reduce benefits - but these were one-off events that can't easily be repeated.
So the challenge of fixing it this time around is even greater.
The number of active DB schemes has fallen from just over 1,200 at the end of 2006 to less than 500 today. The number of active members in those schemes has dropped from 270,000 to 126,000 at the end of last year.
We believe it is time to take a wider look at the Defined Benefit pension structure and its associated solvency measurement, particularly in the current unprecedented financial landscape.
DB schemes that have survived have generally done so because of tough decisions and considerable effort and pain for members and employers. Many employees have seen their benefits reduced. Many employers have had to make significant increases in their contributions. It's questionable whether they will be willing or able to agree further increases.
We have seen the recent report on the market cost of public sector pensions. The Government doesn't have to go to the market to purchase annuities, but neither do private sector defined benefit schemes. Yet, we continue to assume they do when it comes to setting minimum funding standard calculation.
Defined Benefit pensions are crucial to the retirement of many people, it is now time to take a wider look at how they are measured and in particular we need to see a more logical approach taken in the review of the current minimum funding standard basis.
Jim Foley is the chairman of the Irish Association of Pension Funds