THREE OUT of four defined benefit private sector pension schemes are in deficit and the employers' group Ibec warns that the survival of some schemes is in question. It views the minimum funding requirement set by the Pensions Board to be excessive, given "extremely volatile" market conditions, and suggests the funding standard should be relaxed. Many of the defined benefit schemes in deficit also face a tight deadline. By November, those schemes in difficulty must start to inform the Pensions Board how they propose to reduce their funding deficit and how quickly. The purpose of a minimum funding standard is to ensure that, where a pension scheme is wound up, members' benefits are fully protected.
Already many schemes have made painful financial adjustments to meet the minimum funding standard. Employer and employee contributions to company pension funds have been raised and benefits for members and retirees have been reduced. However, despite these changes, recent adverse developments in the euro-zone bond market, in the form of falling German bund yields - or interest rates - have made it even harder for defined benefit schemes in deficit to chart a course to solvency.
The lower yields from German bunds have made the purchase of annuities some 15 per cent more expensive since January. As the funding of pensions schemes is based on the cost of buying annuities for members - and is set by German bund prices - the higher cost has also increased the funding-standard liabilities of schemes. This latest difficulty could hardly have come at a less opportune time. Over the past decade, the cost of funding defined benefit pensions has doubled, due to increases in life expectancy and lower interest rates. And in that period, the investment performance of pension funds has been extremely poor. One concern now voiced is that some employers, if faced with making further contributions to company pension schemes, might instead decide to wind them up.
That fear has partly prompted the Society of Actuaries and the Irish Association of Pensions Funds to make a proposal to Government that pension schemes should be allowed to buy a new kind of sovereign annuity. It would be linked directly to Irish Government bonds which - given their higher yield - would be cheaper than conventional annuities based on German bunds. Such a change would help reduce the funding gap of pension schemes in deficit and greatly ease pressure on companies to contribute more.
An obvious difficulty, however, is that the current higher yield on Irish Government bonds reflects a risk premium that investors demand for the possibility of debt default. German bonds are seen as risk free. The proposal has its merits but also some drawbacks and uncertainties that need to be publicly debated. Lower costs for pension schemes that would result from basing the funding standard on an Irish sovereign annuity, while welcome, would involve higher risk, not least for those least able to bear it - pension scheme members and beneficiaries.