Minister for Social Protection Joan Burton T.D Launches the OECD Review of the Irish Pension

Today the Minister for Social Protection Joan Burton T.D. launched the OECD Review of the Irish Pension system.

Review’s Main Findings and Policy Recommendations:

• Ireland is facing challenges on the financial sustainability of the pension system as the population ages; despite large projected increases in expenditure over the next 50 years, however, Ireland's pension spending will still be comparatively low in international comparison.


• The economic situation of pensioners in Ireland is comparatively good, both with respect to other age groups in the population and in international comparison.


• Ireland and New Zealand are the only OECD countries which do not have a mandatory earnings-related pillar to complement the State pension at basic level; as a result, Ireland, like New Zealand, faces the challenge of filling the retirement savings gap to reach adequate levels of pension replacement rates to ward off pensioner poverty.


• Private pension coverage, both in occupational and personal pensions, is uneven and needs to be increased urgently.


• Pension charges by the Irish pension industry on large occupational Defined Contribution (DC) plans are not too high when assessed on an international context; they are however rather expensive for small occupational schemes and personal pension schemes.


• The existing tax deferral structure in Ireland provides higher incentives to save for retirement to high incomes as the incentives work through the marginal tax rates.


• The Irish legislation regarding the protection of Defined Benefit (DB) plan members is weak. For example, the guarantee schemes in Ireland (Insolvency Payment Scheme and the Pensions Insolvency Payments Scheme) provide partial protection to DB plan members' benefits in case of sponsor insolvency. In addition, the legislation allows any sponsor to walk away from DB pension plans, shutting them down, without creating a high priority debt on the employer. Moreover, the priority currently given to pensioners before other members if a scheme winds up creates large inequalities across members. This outcome is particularly harsh for those close to retirement.


• There is unequal treatment of public and private sector workers due to the prevalence of DB plans in the public sector and DC plans in the private sector


• The State pension system lacks transparency, both with respect to the calculation of benefit entitlements and to the interplay of the contributory and non-contributory pensions.


• The link between contributions and benefits in the Irish State pension scheme is very weak, for reasons spelt out in the report, contrary to what people‘s perceptions of this link may be.


• The State pension scheme could be modernised to encourage working longer in line with the prevailing international trend.


• The new scheme for public servants is being phased in only very slowly and is unlikely to affect a majority of public sector workers for a long time.

Parametric changes in the State pension system

• Within the existing State pension system, Ireland could consider a number of parametric reforms which would improve the financial sustainability of the pension system in the future.


• The long-term retirement age, which at 68 is relatively high in international comparison, could be linked to life expectancy after 2028 in order to ensure that improvements in life expectancy do not significantly extend the duration of retirement.


• To provide incentives for workers to remain in the labour market longer and on the other hand provide more flexibility in making the retirement decision, increments and decrements of the State pension could be introduced for early and late retirement.


• More flexibility could also be provided in allowing retirees to combine work income and pension receipt; this could also ensure better adequacy of retirement income.


• Looking ahead, the adjustment of pensions – which have been frozen in recent years - also needs to be considered as this has a large impact on the evolution of pensions in payment; various options of combining indexation to wage growth and price inflation could be considered.

 

Structural reform of the State pension system

• Given the complex structure and the inequities resulting from the benefit calculation method in the public pension scheme and the interplay between the contributory pension, the non-contributory pension and other means-tested elements of retirement income provision, Ireland should consider a structural change of the State pension scheme.


• At a minimum, the current inequities in the treatment of workers‘ contributions to the system should be removed and all contributions made should be honoured in the calculation of the pension benefit, as foreseen in the current plans to adopt a total contributions approach from 2020 onward.


• The best two options out of the three described in the report, for a structural reform of the State pension scheme are: a universal basic pension or a means-tested basic pension. Both of these options would have the advantage, compared with the existing scheme, of introducing a much simpler, more transparent and less costly public pension scheme.

 

Option 1: a universal basic pension scheme

• A universal basic pension scheme for the entire population would be based on residency requirements, provide a single flat-rate benefit and cover all of the Irish population, regardless of their life-time work or contribution status. It could be financed by taxes, contributions or a combination of the two.


• A basic pension scheme could be complemented with either mandatory private pension provision or auto-enrolment into to private pension schemes.  Participation could be targeted at workers above a certain income level as workers on low earnings would already be receiving a comparatively high replacement rate through the basic pension.


• The Household Benefit Package and Free Travel Scheme could either be transformed into a cash supplement and merged with the basic pension or it could be awarded to pensioners who need the extra benefit as a means-tested cash supplement.


• Setting the level of such a basic pension for all citizens in order to meet the twin goals of social adequacy and financial sustainability would require more detailed analysis, including the costing of alternative revenue scenarios.

 

Option 2: a single means-tested pension

• An alternative would be a single means-tested pension financed out of general revenue. The Household Benefit Package, the Free Travel Scheme, and other means-tested "advantages" would be included in the pension amount.


• The main design issues to be addressed under such a scheme would again be the appropriate level of the means-tested benefit, at what schedule the benefit should be withdrawn for higher earnings, what type of administrative arrangements would be needed and how much this scheme would cost under alternative scenarios.


• Combining the public and the private pension pillars, a means-tested scheme would function best in combination with mandatory participation in private pension plans. In a voluntary scheme, even with an auto-enrolment mechanism, there would be disincentives to contribute to a private pension, unless a certain amount of pension savings were exempted from the means-test for lower-earning groups.

 

Reform of the public service pension scheme

• At a minimum, a faster phase-in of the new rules of the occupational scheme for public servants should be considered; this would entail including existing public servants in the new scheme based either on a certain cut-off age or on length of service.


• Any new private pension scheme for private sector workers should also be extended to public servants, at a minimum for new entrants but ideally also for some of the existing public servants.

 

Policy options to expand private pensions coverage and retirement savings

• To increase adequacy of pensions in Ireland, there is a need to increase coverage in funded pensions. Increasing coverage can be achieved through (1) compulsion, (2) soft-compulsion, automatic enrolment, and/or (3) improving the existing financial incentives.


• Compulsion, according to international experience, is the less costly and most effective approach to increase coverage of private pensions (OECD Pensions Outlook, 2012, Chapter 4).


• Automatic enrolment is a second-best. Its success in increasing coverage depends on how it is designed and on its interaction with incentives in the system.


• The cost of establishing and managing auto-enrolment may be higher. Auto-enrolment requires monitoring, accurate record-keeping, fiscal incentives and careful design. Implementing a centralised institution to manage the system and provide default investment options would add to the costs.


• There is a misalignment to correct between the existing tax deferral structure in Ireland that provides higher incentives to high-income earners and the policy goal of increasing coverage, especially for middle to low-income people.


• International evidence (Germany, Australia, and New Zealand) suggests that flat subsidies and matching contributions increase incentives to save for retirement for middle to low incomes.


• Existing private schemes need to be subjected to the same rules as the new schemes under auto-enrolment or compulsion.

 

Improve the design of DC arrangements

• The design and institutional set-up of DC pension plans need to improve in line with the OECD Roadmap for the Good Design of DC Pension Plans.


• Establish appropriate default investment strategies, while also providing choice between investment options.


• Establish default life-cycle investment strategies as a default option to protect those close to retirement against extreme negative outcomes.


• Encourage annuitization as a protection against longevity risk. For example, a combination of programmed withdrawals with a deferred life annuity (e.g. starting payments at age 85) could be an appropriate default.


• While still keeping the principle of pension savings being ―locked away, the Irish Government could consider allowing withdrawals strictly only in the event of significant financial hardship.


• Specialised private institutions (e.g. pension funds, asset managers) should manage the assets. The establishment of an autonomous public option could be envisaged to provide competition, lower costs, and a default pension fund for those unable or unwilling to make investment or fund choices.

 

Enhancing benefit security in DB schemes

• Strengthen the Irish legislation regarding the protection of DB plan members when plans wind up. For example, healthy plan sponsors should not be allowed to ―walk away from DB plans unless assets cover 90% of pension liabilities. This funding requirement would introduce some type of guarantees for members and it would allow at the same time some degree of risk sharing. The funding ratio should be calculated following prudent standard actuarial valuations. Moreover, the priority currently given to pensioners before other members if a scheme closes because of sponsor bankruptcy should be eliminated.


• Further legal reforms may be needed to introduce more flexible DB plans that for instance allow for accrued benefits to be cut in case of underfunding (e.g. the Netherlands) and, more generally, for risks to be shared between plan members and pensioners, as well as plan sponsors.


• Establish a clear framework to facilitate domestic investment in infrastructure projects, but a general subsidy to all infrastructure projects should be avoided as it would distort capital allocation. It is clearly desirable that pension funds should help support economic growth in Ireland, but the objective should not be used as an excuse to impose low returns on pension fund members.


• Revise the new funding standards as they may create new risks for pensioners by offering strong incentive for pension funds to invest in Government bonds, in particular sovereign annuities.

Further comment and analysis to follow.

OECD Review: Financial Sustainability

In our last post on the OECD review, we discussed how Ireland's policy stance measured up against key criteria, looking at the performance of the Social Insurance Fund. Another item on the OECD's agenda is that of financial stability and how it is evaluated through international analysis. The first step to this evaluation is to look at international comparisons. 

As you can see from the chart below, in 2010, Ireland ranked somewhat average in our public expenditure on pensions, with the inclusion of all government pension costs; contributory, social welfare pensions, non-contributory pensions and public sector pensions.

If you look at the next chart, you can see that the projected change in expenditure is quite significant between 2010 and 2060, Ireland projected to rank third on the table.

The charts highlight the rising cost of State funded pensions which the National Pensions Reserve Fund (NPRF) was intended to offset.

Broadly speaking 1/3^rd of the NPRF covered public sector pensions whilst 2/3rds covered social welfare pensions.

The fastest increasing cost is public sector pensions. These grew from an estimated capital cost of €75bn in 2007 to €129bn in 2009. No figures have been produced since, however it is likely that that cost has continued growing.

Source: OECD Review of Pensions in Ireland, 14.09.2012. John Martin, Edward Whitehouse, Anna D'Addio, Andrew Reilly.