Why Aren't Irish Pensions Smiling?

As the White House fountains ran green, President Barack Obama met Irish Prime Minister Brian Cowen, paying tribute to the "strongest bonds" between their nations on St-Patrick's Day.

In recession and war, people love celebrating St-Patrick's Day:

Tens of thousands of marchers proceeded up Fifth Avenue on Tuesday for the annual St. Patrick’s Day parade, the festive mood of the procession — believed to be the 248th — tempered by the deteriorating economy in both the United States and Ireland.

These days, however, Ireland doesn't have a lot to smile about. In fact, Ireland went from hero to zero in the eurozone - in one small bound.

What led to this reversal of fortunes? The most important factor is that just like in the United States, the FIRE sector (finance, insurance and real estate) made up a huge proportion of the Irish economy. When several bubbles burst at once, the impact jolted the Irish economy.

The crisis in capital markets has also clobbered Irish pension funds as they have tumbled 7.5% in 2009:

Pension funds recorded another disastrous month in February with losses of 5.7pc coming on top of losses in January and massive falls last year.

Irish pension funds have now declined by 7.5pc so far in 2009, according to a new report.

In February, pension funds lost 5.7pc following on from a 1.9pc loss in January, according to the Pension Managed Funds Survey by Rubicon Investment Consulting.

Standard Life Investments was best performer over February, recording a loss of 5pc. Irish Life Investment Managers was the worst performing for February, losing 6.6pc.

Over the past 12 months, funds have crashed by 34.5pc, with returns ranging from a loss of 29.8pc in Eagle Star to a lost of 38.1pc with Irish Life Investment Managers.

The average managed-fund return also recorded disappointing results, down 14pc per year for the last three years.

And pensions experts warned that the losses were likely to continue for the time being.

Hewitt Associates' Evelyn Ryder said the latest poor performance would come as a huge blow to investors who would have been hoping that equity markets had reached near bottom following the recent period of stabilisation and that the start of a recovery was imminent.

The recent deterioration in equity markets has highlighted that market uncertainty remains at critical levels and there is a distinct possibility of further falls to come in worldwide markets, she added.

"The continuing volatility in financial markets is adversely affecting fund performance. The global markets are falling on the continuing uncertainty as to the future viability of some of the world's biggest financial institutions.

"They are also reeling from the steady flow of economic data which is highlighting the extent of the current global recession," she added.

"The outlook remains bleak for investors as the scale of the problems facing countries and companies across the world continues to escalate."

The five year returns to the end of February are also negative, with the average managed fund delivering a return of -3.0% per year over this period (click on table above to see returns).

All this prompts Caroline Madden of the Irish Times to ask, Are we throwing good money after bad into pensions?:

Global stock market losses have proved particularly galling for Irish pension investors. After saving diligently and regularly for their retirement years, many now find that a shocking amount has been wiped off the value of their pension.

Despite the protestations by some investment experts that now is the perfect time to buy into equities, some pension savers will be wondering whether they’re simply throwing good money after bad by continuing to contribute to their retirement fund.

Already this year, Irish pension funds have lost an average of 7.5 per cent and the long-term performance isn’t more compelling. In the past three years, the average Irish managed fund has weakened by 14 per cent each year. In fact, the average fund has failed to beat inflation over the past 10 years.

Employees in defined contribution schemes have become increasingly disillusioned as significant chunks of their pension have vaporised each month. And some, especially those closer to retirement, now wonder whether future contributions will also prove to be more money down the drain.

“It would be,” says Ian Mitchell, managing director of Deloitte Pensions and Investments, “unless they put it in a cash fund”. Even though the level of return offered by cash funds is low, if a person is entitled to tax relief at the higher rate on their pension contributions, this return alone will make it an attractive proposition.

Fiona Daly of Rubicon Investment Consulting points out that, if an individual is a member of an occupational pension scheme, their employer will probably contribute to their retirement fund as well. So if, for example, an employee’s monthly contributions of €100 are matched by their employer, a total of €200 goes into their pension pot each month.

After tax relief is factored in, this only costs the individual €53. “So even if the €200 has fallen 50 per cent, they still have €100, €53,” she says.

While tax relief makes for a very compelling argument, pension savers must remember that, to a large extent they are simply deferring, rather than saving, tax. When they eventually draw down their pension, it will be taxed in the same way as any other income.

If a person’s pension fund is already invested in stock markets, Mitchell says they shouldn’t necessarily move it into a cash fund now if they still have several years to go before retirement.

Although the bottom has yet to be called on the stock market freefall, at some point in the next 10 years equities may be higher than they are now.

Daly agrees that people should be wary of moving any money already in a pension fund into cash. “If it’s already in equities, moving it into cash will crystallise the loss,” she explains.

She says that it could be argued that now is a good time to buy equities as they are very cheap. Of course that assumes the companies survive. In the Irish market where bank nationalisation is a real issue, investing in equities continues to look high risk.

If people are uncomfortable with putting their money into equities now, they should be able to redirect future contributions for the next year or so into a cash fund, she says. Most company pension schemes allow members to make this type of switch at least once a year.

They will “lose on the upturn when it happens”, she points out, but it will protect them from some of the stock market volatility. Many people now find that their financial circumstances are becoming considerably tighter as the recession deepens. If they’ve taken a pay cut or their spouse has lost their job, monthly pension contributions that were affordable in the past may now represent a considerable burden.

Is it possible to reduce these contributions until their situation improves, or even take a pension holiday?

It all depends on the rules of their company pension scheme. “If they’re in a defined contribution scheme where the rules state that they have to make certain contributions, then they may have no choice,” says Daly.

However, Mitchell encountered a client who told her employer she could no longer pay her pension contributions, and her employer was “quite generous” and not only allowed her to take a break, but also said that they would continue making the employer contributions to her pension.

“It involved a rewrite of the scheme rules,” he says. His client had to be moved into a special category of members that were not required to make pension contributions. It’s not that easy, but it can be done, he says, although if an employer is looking for a reason not to contribute to the pension fund, depending on the scheme rules they may well be within their rights to stop contributing.

Reducing or taking a break from AVCs is more straightforward, as contribution amounts can be changed, stopped or restarted at any time. However, if the AVCs were set up on a high commission basis, it’s possible that the individual may face a penalty. A lot of AVCs are set up on a nil commission basis, so this shouldn’t be an issue.

What if an individual’s financial circumstances have deteriorated to the point where they are considering raiding their retirement fund? Is this even a possibility?

Daly explains that it is only possible to withdraw your pension contributions from an occupational pension scheme if you leave within two years of joining. She warns that in this situation, the individual will not only pay tax on the amount that they get back, but they will only receive the current value of their contributions, as opposed to the full amount that they originally paid in.

She says that it’s “pretty much impossible” to withdraw AVCs in advance of retirement as Revenue does not allow it. The only possibility is if the person manages to “swing early retirement”, she says, and if they can afford to leave the workforce early, then raiding their pension probably isn’t a priority.

Despite the dire state of public finances, the Irish government has stuck with its plans to continue with significant capital expenditure projects in 2009:

There are a number of reasons for this. Major infrastructural projects provide employment. At a time of substantial and growing unemployment, the net cost of such projects is reduced by the fact that they bring people off the dole, and create income tax receipts.

Borrowing to invest in infrastructure that adds to the wealth and productivity of the State is more justifiable than borrowing to pay for day-to-day expenditures.

For this reason, borrowing for capital expenditure is not frowned upon by the international markets to the same extent as, say, borrowing to pay welfare payments. Also, with the economy generally, and the construction sector in particular, in a deep slump, significant cost reductions in the prices of land, materials and labour can be had.

Early last month when announcing the pension levy on public sector pay, the Government said it would be seeking savings of €300 million arising from such factors.

This would bring the planned outlay on capital expenditure to €7.93 billion from €8.23 billion, it said. “There will be increases in allocations to labour-intensive sectors to be funded by reductions in other areas.”

The question now is that given the further deterioration in the economy and the public finances, would it on balance be better to put a few of the planned projects on hold, for a year or so.

Transport has a €2.88 billion estimate for capital expenditure this year while Environment, Heritage and Local Government has an estimate of €2 billion.

Education and Science has a budget of €889 million.

The transport budget is mainly devoted to the improvement of the road and rail infrastructure.

Work is under way on the major road routes between Dublin and Galway, Limerick, Cork and Waterford as well as on the extension of the Luas to Cherrywood, the Docklands and Citywest and the western rail corridor project.

Projects planned to begin construction this year are the Castleisland bypass, the electrification of the Maynooth rail line, and the Marlborough Street Bridge, in Dublin. There is also a range of lower order, ongoing works such as minor roads, quality bus corridors and railway safety infrastructure.

A significant part of the Environment, Heritage and Local Government expenditure is taken up with water and sewerage improvement schemes. The 2008 figures show that €471 million of that year’s capital expenditure allocation went on water and sewerage projects. While such work is necessary, there may be scope for delaying some projects so as to ease the State’s overall borrowing requirement.

As far as Education is concerned, the renovation of old schools and the building of new schools may be the area of relatively labour-intensive work as well as being an area where particularly sharp reductions in costs could be achieved. There have been ongoing queries about the efficiency of the department’s school building operation, and in particular the interaction between the parts of the department responsible for temporary and permanent school building provision.

Overall, much of the capital expenditure due to occur during the remaining nine months of this year may be already contracted for and so delaying or cancelling the projects could incur costs for the State.

Some commentators have said there may be scope to channel the very substantial savings and investments that have been accumulated during the boom years, to fund some of our infrastructure programme.

The Bank of Ireland produced a Wealth of the Nation report for 2006 that estimated that the gross assets of Irish households were approximately €800 million net.

The collapse in property prices and the value of shares in addition to other assets has without doubt reduced that figure significantly but there must still be a considerable number of millions of euro in net wealth in society.

If savings could be channelled into bonds that were kept off the State’s balance sheet, then the funds could be used to invest in infrastructure and create employment.

The Government’s annual 1 per cent of GDP payment into the National Pension Reserve Fund (NPRF) is considered to be capital expenditure. The figure for this year as per the Government’s plan produced in January for the European Commission was €1.69 billion. On the face of it, it appears odd to be borrowing money abroad to invest it in a pension fund, especially one that has lost a lot of money through the punishing loss in share values in recent times.

However, the AIB and Bank of Ireland recapitalisation scheme is be funded from the NPRF. As Minister for Finance Brian Lenihan said at the time the recapitalisation was announced, “€4 billion will come from the fund’s current resources while €3 billion will be provided by means of a front-loading of the exchequer contributions for 2009 and 2010”.

In other words, the money is not being set aside but rather is going to be put into the two main banks as part of the programme aimed at nursing them back to health.

The fund is also apparently well regarded by the international markets and rating agencies. Rating agencies can influence the interest rates Ireland is obliged to pay on its borrowings by altering the rating they ascribe to the State. These same agencies gave triple A ratings to the securitised loans based on US subprime mortgages that have since triggered the international banking crisis, but regard is still paid to their views.

The pension reserve fund has served as a buffer for Ireland in the first stages of the sudden and severe economic downturn.

Overall, the January plan envisaged the State maintaining a capital expenditure programme equal to between 4.4 and 4.6 per cent of GDP in the years to 2012, and the Government will now have to re-examine this. The plan envisaged that by 2012 the economy will have begun to grow again.

The contraction that is occurring in the economy, and the falling levels of wages and costs, should eventually return Ireland to competitiveness. If growth returns in 2012, it will be from a much lower base and will be a factor of a number of issues, including infrastructure.

According to the 2008 preliminary results, the Fund’s investment return from 1 January to 30 December 2008 was minus 29.5 per cent, reducing its annualized performance since inception in 2001 to 0.6 per cent (compared to 6.0 per cent at end 2007). Its market value at 30 December 2008 was €16.4 billion.

These results are hardly surprising. The Fund is heavily exposed to large cap equities (56%), private equity (10%) and property (8%).

Finally, the deterioration in the public finances and the pension system has recently prompted the Irish government to pass legislation allowing a pension levy on public sector workers:

Under the terms of the Financial Emergency Measures in the Public Interest Bill 2009 the Irish government intends to introduce an average pension levy of 7.5% on civil servants earning €50,000, although this reduces to 4% after tax relief, in an effort to meet its cost-cutting target of €2bn.

The new deduction, which will not actually increase members' pension benefits, is estimated to save the government €1.16bn in 2009 and €1.35bn in a full year.

Brian Lenihan, the minister for finance, stated in the Dáil last week that the measures would apply to "all public servants serving on or appointed after 1 March 2009".

In the debate on the second reading, held yesterday in the Oireachtas – the Irish Parliament - deputy Martin Mansergh, a minister of state, told members of the Dáil, the house of representatives, that the Bill recognises "on a cost-benefit basis public sector pensions are on average worth a great deal more at the present time than the average private pension".

He added: "The pension levy, though unpopular, is an attempt to establish greater fairness across different sectors of the economy, but is above all designed as the least unacceptable way to relieve what has become an unsustainable level of government expenditure."

Mansergh also pointed out in the past "many measures, including income tax, have been introduced on the falsely optimistic understanding that they were temporary. The minister for finance has correctly given no such assurance in relation to the pension levy".

Meanwhile, deputy Chris Andrews, a TD for the ruling Fianna Fáil party, admitted the levy "will be difficult for everybody to swallow", but warned "we must not skirt around the difficulties and there can be no escaping the facts, regardless of how unpalatable they may be. We are in the midst of a global recession whose effects are being felt in every developed country."

The government representatives pointed out the economy has deteriorated at a faster rate than expected and "the State will have to borrow €18bn this year at steeper interest rates to finance current and capital spending", which equates to €4,500 for every man, woman and child.

Andrews told the Dáil: "Yes, the pension levy will be difficult for people. However, it is only the first step and there will be significantly greater pain to come for all sections of society."

However, trade unions are continuing to oppose the introduction of the levy, and following a mass demonstration on 21 February organisations are urging members to vote in favour of industrial action if the government fails to agree to a three-year plan.

The Irish Congress of Trade Unions (ICTU) said it recognised the "enormity of the crisis facing our society and all our citizens" but revealed it has formulated a "10-point solidarity plan" as the basis for a medium-term agreement to ensure more fairness.

Following a meeting of ICTU's executive council yesterday, the trade union body said "thus far Congress has been unable to persuade the government and employers of the merits of this approach".

The executive council confirmed it had therefore decided to "advise affiliated unions" that they are entitled to resort to industrial action and "to be prepared for this contingency, it is recommended that unions should ballot their members commencing next Monday, concluding over a period of three weeks, seeking a mandate for industrial action up to and including strike action".

The Teachers Union of Ireland (TUI) has already opened a ballot on potential industrial action, which could include strikes, work to rule and non-cooperation or withdrawal from various initiatives.

Peter MacMenamin, general secretary of the TUI, said: "TUI acknowledges that we are in severely difficult economic times. However, any viable national solution must first involve a fair sharing of the remedy. What we are currently seeing imposed is a patently unfair and unjust targeting of the public service for further punishment.

"Our members see the so-called ‘pension levy’ salary cut as a bridge too far – unfair, unjust, unpalatable and unacceptable. Enough is enough. We encourage all members to vote ‘Yes’ and in doing so give a clear mandate to TUI’s national executive committee to engage in whatever action it deems appropriate to oppose this latest attack," he added.

People should pay attention to what is going on in Ireland because in the not too distant future, I suspect pension levies will hit North America's public sector workers. When that happens, Irish eyes everywhere won't be smiling quite as hard as they used to.