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.
- 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.
- 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.
- 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.
- 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.
- 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.
