The DB Pensions Crisis

The Irish Times carries an important op-ed by Michael Walsh of Mercer on the crisis in the defined-benefit pension system.  Compared to the fiscal, banking and employment crises, the DB pensions crisis is largely below the radar — but still hugely important.  

The focus of the article is on the need for policies to ease pressures on sponsoring businesses, and to prevent the more radical response of winding up existing schemes.  Of course, the proposals have potentially huge implications for a key component of the wealth of many Irish workers.  Unfortunately – but perhaps inevitably in an 850 word article – the actual reforms being proposed are less than clear.  I hope the diverse readership of this blog can provide some clarifications and perspective. 

There are two proposals:

First:

The Society of Actuaries and the Irish Association of Pension Funds have put a proposal to government to address this issue. It would involve insurers being allowed to sell, and pension schemes being allowed to buy, a new kind of annuity. These so-called sovereign annuities would be directly linked to Irish government bonds. They would therefore be much cheaper than conventional annuities. This would increase the chances that pension schemes can continue to operate and make good current funding deficits over time.

How exactly would these sovereign annuities work?  That they lead to cheaper annuities immediately suggests a reduction in the present discounted value of the expected benefit stream – that is, a loss in wealth. 

And second:

Our proposal at Mercer is that pension schemes that wind up be permitted to pay lump sums to pensioners instead of buying annuities. The lump sum would be the capital value of the person’s pension calculated on a prescribed basis. The calculation would allow for current life expectancy and expected future mortality improvements together with a specified long-term rate of interest or a rate linked to average euro-zone bond yields. Pensioners could then put the money in an Approved Retirement Fund from which income could be drawn down. Alternatively, they could use the money to buy an annuity, although if this is done at the current time it would likely be for a lower amount than their previous income from the pension scheme.

The proposal as written comes across as relatively painless.  But as Michael says, the devil is in the details.   What exactly is the “prescribed basis”?   Again, there is a presumption that any reduction is the contingent liability of the sponsor is also a reduction in the contingent asset of the member.

Michael Walsh may well be right that, all things considered, such reforms are warranted.  But the stakes for many individuals are such that a public debate is crucial, notwithstanding the complexity of the issues involved.