The State’s pension landscape has been the subject of significant upheaval in recent years. Nowhere is this more seen than in the area of defined benefit schemes, many of which have been wound up due to lack of solvency or have had to be renegotiated with dramatically reduced benefits for members.
Demographic trends have played a key part in this, especially greater longevity. Where once a defined benefit scheme guaranteed a retiree an income for an expected 10-15 years until death, now that same scheme can expect an average worker to live 20-25 years, playing havoc with old actuarial calculations.
In looking at the future of pensions, demographics are therefore key. One of the most startling figures in this area is the ratio of workers to retired people. Currently, there are 5.7 workers for every retired person. By 2040, however, that figure reduces dramatically to two workers.
The Government has largely been able to maintain the level of State pension for now, but its ability to do so in the future will become increasingly unsustainable as the dependency ratio increases. According to a report by Insurance Ireland, State spending on pensions could rise from 5.2 per cent of GDP in 2007, to 8 per cent in 2035 and 11 per cent in 2060.
The current Framework for Government includes the introduction of a mandatory/ auto-enrolment pensions regime when economic circumstances allow. The call for a mandatory scheme was endorsed by the OECD 2013 report Review of the Irish Pensions System. Exactly when this will happen, however, remains unclear.
Low participation
Previous attempts to tackle low participation in pension schemes proved unsuccessful with PRSAs not proving popular. What is being suggested now is a system whereby all employees over the age of 22 would be automatically enrolled in a scheme with minimum contributions by the employee, the employer and the State. Employees would need to opt out but would be re-enrolled every two years and would have to continue opting out.
The success of the introduction of mandatory enrolment in the UK should prove encouraging. The scheme there also operates on the basis of leaving it to employees to opt out. “The power of inertia works and despite scepticism, opt out rates of less than 10 per cent have been achieved,” says Alastair Byrne of State Street Global Advisors. “International experience suggests it works too – very low opt out rates were achieved in the US too.”
In a carrot and stick approach, a huge degree of flexibility has been introduced into the UK with employees able to control what they do with their pension pots rather than having to purchase annuities.
“Some of the coverage of this announcement focused on the potential for people to blow their savings on luxury cars and yachts. It’s improbable to suggest that people who have had good prudent savings habits all of their lives are suddenly going to act irresponsibly. Evidence from the US where this was introduced, is that almost half of people didn’t access any of their savings between the ages of 65 and 70,” Byrne says. The new arrangements come into force in the UK next April and Byrne says that huge opportunities exist for the asset management industry. How the Government reacts to consumer will be crucial.
Buy-to-let property
One potential source of investment is buy-to-let property, sparking fears that this may aeffect the property market. In Ireland, the Government also has a key role to play in encouraging pension investment. Munro O’Dwyer of PwC feels that there is a lack of joined up thinking in regard to pension policy and that consumer engagement and awareness remains poor. “The approach has been piecemeal, between levies and the moving out of the state pension age to 68. A mandatory scheme should have been introduced at the same time.
“It’s surprising also that when people express concern about issues such as water charges and how that affects their finances, they are not taking account of the fact that €12,000 a year or €36,000 has been removed from their retirement incomes,” he says.
DEATH OF THE ANNUITY?
Whither the humble annuity? Once the staple of retirement plans, retirement annuities have got a bad name lately with the perception that they offer miserly rates of return – with rates halving over the past 10 years.
In some countries, they have become an endangered species. In a presentation last month at an Insurance Ireland conference, Peter Nielsen of the Financial Services Council of New Zealand reported that only three annuities had been purchased in the country last year.
Meanwhile, closer to home in a budget that was characterised as a ‘bonanza for cruise companies and sports car makers’, the British chancellor, George Osborne, scrapped compulsory annuities, allowing pensioners much greater freedom over their pensions (see main piece).
“It’s reasonable to expect that less people will buy annuities at retirement,” concedes Alastair Byrne of State Street Global Advisors but he feels they still have a place.
“Looked at it from the point of view of someone retiring at 60 or 65 they may not seem attractive. However, when you get to 75 or 80, guaranteeing an income for the rest of your life becomes more important so we are likely to see a shift to later stage purchase.”