Proposed changes to insolvent defined benefit schemes

The Minister for Social Protection announced recently that she secured Government approval for measures to tackle the problems facing defined benefit pension schemes. I am going to have a look at those solutions, but first, we need to look at what the problems are and what the current rules say regarding insolvent defined benefit schemes.

 Problems

1.  Pension funds have suffered significant losses over the last number of years. Research has shown that Irish pension funds invest a higher proportion in more volatile equity based investments, leaving themselves open to greater losses.
2. Under defined benefit schemes, the employer guarantees the benefit paid at retirement. With the recent recession, employers simply do not have the money to make up the shortfall in the fund created by the fall in fund value.
3. People are living longer. The annuity commitment the fund makes is costing the fund more than they had planned for.
4. Funds are top heavy. Companies are cutting back on recruitment, so there are less people paying into the scheme each year. But the number of pensioners taking out of the fund is increasing all the time.
5. Schemes cannot carry surpluses. This has resulted in companies having to cease making contributions when the fund is doing well. They are not allowed to have a “rainy day” element of the fund to compensate when the fund isn’t performing.

Current Rules for winding up pension schemes

This is the order in which the assets held within a defined benefit pension scheme are distributed on scheme wind-up

1. Cost of wind-up
2. AVC’s are refunded
3. Pensions in payment (excluding any scheme rule increases)
4. Benefits for current and deferred members (excluding any scheme rule increases)
5. Post retirement scheme rule increases for all
6. Any other scheme rule benefits

With the cost of securing annuities for those who have already retired, the current and deferred members see very little, if anything at all in the situation of scheme wind up. Even if you are 1 day from retirement, you will probably lose all of the benefits you have obtained. Some defined benefit schemes appear to be nothing more that Ponzi schemes with younger members paying for pensioners. With fewer new members to the scheme, those at the bottom will end up with nothing.

Proposed changes

The proposed changes will be addressed in two different scenarios:

 Both defined benefit scheme and employer is insolvent

1. 50% of the pension is protected for both pensioners and active and deferred members. Those on pensions of €12,000 or less are guaranteed 100% of their pension (Old Age Pension is additional).
2. If there is anything left, the pensioners have their annuity topped up to 100%.
3. Current/ deferred members have their benefits topped up from whatever (if anything) is left.
4. If there is not enough money to cover the 50% minimum protection level (or 100% of pension is less than €12,000), the government will pay for it from the pension levy.

Defined Benefit Scheme is insolvent but employer is not

1. Pensioners receiving pensions of less than €12,000 are prioritised and get 100% of their pension.
2. Pensioners who receive between €12,000 and €60,000 receive 90% of benefits.
3. Pensions who receive over €60,000 receive 80% of benefits.
4. Once the retirees have been paid, the current/ deferred members receive 50% of benefits.
5. If there is anything left at this stage, pensioners get their annuities topped up and then current/deferred members
6. As the company is still trading, there is no government funding in this situation.
7. The same type of structure applies in the situation where the pension scheme is being restructured.

While these changes have given current/ deferred members some element of protection, they are still very vulnerable as the majority of defined benefit schemes are underfunded (70% in 2011). Next week I will look at the option of transferring out the value of your defined benefit pension. For the rest of us who are saving for retirement, I think it is clear that the pension levy which was only supposed to be in place for 4 years will be around for a long time.