Simon Hoffman, pensions and investment director with Friends First, explains why reforms should be introduced to restore confidence and improve the affordability pensions.
The pensions’ issue or crisis is as real in Ireland as any other developed economy, although the imminence of the problem is somewhat further down the road due to the still relatively young age profile of the population.
However, these demographics are changing and the CSO is projecting that the over-65 age cohort or the old population in Ireland is set to grow from 532,000 in 2011 to between 850,000 and 860,700 by 2026, and to almost 1.4 million by 2046.
OECD review
Against this background, the Government did what Governments do best – they commissioned a report into what our best options to address this issue might be. In April of this year the OECD published a very strong and comprehensive review of the Irish pension situation. Its terms of reference included an examination of the state scheme and other public benefits, schemes for public sector workers and personal and occupational plans. The Preliminary Summary of the report ran to 178 pages and without trying to do it an injustice its general findings were:
• State Pension: Move to a single State pension which is residency, rather than contribution, based. This could be either a flat rate or means tested benefit.
• Public Service Pension Schemes: A faster phase in of the new rules to existing employees.
• Defined Benefit Schemes: Enhancing member security in cases of scheme wind-ups.
• Private Sector Pension Schemes: Increasing coverage and adequacy is vital and a number of strategic directions where outlined.
Increasing private sector coverage
It has long been understood that the State can only provide a basic safety net to avoid poverty in retirement. It is up to private provision to ensure adequacy of retirement income. The question is really how do you make it happen? Outside of the public sector, approximately only 40% of workers have a private pension. Despite a number of initiatives over the last couple of decades, this figure has remained stubbornly low. The OECD report recommended we look at one of three strategic directions in this regard:
• Compulsion: Where every employer in the State would be obliged to provide a contributory pension scheme for all employees. Such schemes would usually entail the employee, employer and the State contributing to the pension.
• Soft’ compulsion: Sometimes referred to as ‘auto-enrolment’, it differs from compulsion in that although all employees would have to be enrolled in a pension scheme when they start work, they could ‘opt-out’. It is envisaged that should an employee stay in the scheme the employee, employer and State would contribute to the pension.
• Improve existing financial incentives: The OECD concluded that current incentives are not configured to appeal to the segments of the population which need to be targeted. Tax-based incentives tend to favour those on higher incomes who pay higher taxes.
Each option has its pros and cons. Compulsion is likely to be unpopular as individuals struggling to meet day to day expenses and view it as another ‘tax’. Business will see it as increasing the cost of employment. There is also the ‘dumbing-down’ effect. To make mandatory pensions palatable, you have to set low minimum contribution levels which introduces the real danger that pensions schemes where contributions are above this level will ‘dumb-down’. Soft compulsion is politically more appealing as the ‘opt-out’ aspect distances it from being perceived as a ‘tax’. However, employers won’t have the luxury of being able to opt-out so the addition to the cost of employment issue remains. My own view is that the third option of improving financial incentives is not really a third option. It is an essential aspect of any reform. Whether you compel or encourage people to take up private pensions, a simple approach with clear and targeted incentives is key. Our current system is complex, which is a large barrier to take up. The OECD enforces this view in pointing out that the key success criteria for auto-enrolment is scheme design.
What next?
The report is to be welcomed as it has brought the pensions issue into focus yet again. It concluded that although there is no blueprint for reform which Ireland could take off-the-shelf and implement directly, we can learn from examples implemented in other jurisdictions, but any solution will have to fit Irish circumstances.
However, we have been here before. Back in 1996 we had the National Pensions Policy Initiative. In 2005, we had the National Pensions Review, in 2010 the National Pensions Framework and now in 2013 we have the OECD Review of the Irish Pension System. Pension coverage has not changed materially since the NPPI back in 1996. And although our relatively young population does give us the time to get this right, time passes and we have 17 years less time now to get it right than we did when the NPPI was published.
Despite these uncertainties and lack of clear policy advice, it is imperative that policy makers take the first steps in putting a system in place that will ensure adequate post retirement income for everybody. The longer-term economic consequences of not doing this will be very serious, and result in future obligations which neither the State nor tax-payers will be able to meet.
