Overview. A Brief History. Pension Policy for Financial Crises: Experience in Canada, Ireland, the UK and the US

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1 Pension Policy for Financial Crises: Experience in Canada, Ireland, the UK and the US Gerard Hughes and John Turner Presented at the ENRSP Conference Protecting Pension Rights in the Economic Crisis Leuven, Belgium June 2009 Overview Decline of DB & growth of DC schemes Effect of financial crisis on pension assets Policy options for coping with the crisis Responses in individual countries A Brief History In the 1950s, 1960s, and 1970s, employer- provided pension plans in the US, Canada, the UK, Ireland, and other countries were almost entirely defined benefit (DB) plans Starting in the 1980s or perhaps earlier in the US, with later timing generally in other countries, there has been a move away from DB plans 1

2 Sharp Declines In the US, 401(k) plans have largely replaced DB plans, with the trend continuing. In the UK, DC plans have largely replaced DB plans with the trend starting later and occurring more rapidly, following changes in accounting rules. Modest Declines In Canada and Ireland, the decline in DB plans and growth in DC plans has been less rapid DB plans still predominate in both countries. Effect of the crisis on pension assets in

3 Policy Options for Underfunded DB Plans Relax funding standard Reduces impact on required contributions Allows time for stock market to recover Reduce benefits Recognise only a proportion of salary increase as part of pensionable pay Change order of priorities for pension entitlements Use hybrid plans Policy Options for Underfunded DB Plans (Contd.) Close DB scheme Existing members continue to accumulate benefits Freeze benefits Active members do not accumulate any further benefits Transfer liabilities to insurance companies via pension buyout market Endgame for DB plans Policy Options for DC Plans Reduce contributions Defer purchase of annuities Allows time for stock market recovery but does not avoid risk of lower pension Allow catch-up contributions in excess of normal limit Allows accelerated build up of fund 3

4 Experience in Ireland Value of pension assets fell by 35% in 2008 At end 2008 gov.. memo revealed 90% DB schemes underfunded Responses by Pensions Board DB schemes given 18 rather than 12 months to prepare proposals for meeting MFS 10 year period allowed to eliminate deficit extended subject to funding proposal Members of DC schemes defer annuity purchase Experience in Ireland (Contd.) Responses by employers Continue closing DB schemes to new members (benefits continue to accrue for existing members) Freeze DB schemes (no further benefits accrued) Reduce benefits by counting only part of salary increase as pensionable pay or using lower accrual rate Experience in Ireland (Contd.) Responses by Government Pensions Insolvency Payment Scheme (State annuity payable where scheme & company both insolvent) Change entitlement priorities in wind up (no pension increases for existing pensioners) Restructure by sharing burden among current & former members & pension increases 4

5 Responses to Pension Risk in Irish DB Schemes Experience in the UK Value of pension assets fell by 14% in 2008 DB scheme specific approach recovery period can vary from 1 to 20 years Regulator used his power to force companies to put payments into fund ahead of dividend payments Similar policies adopted to reduce benefits as those used in Ireland Buy-out market used to transfer DB schemes to insurance companies Forms of Benefit Changes Under Active Consideration and Recently Implemented in UK, January

6 Convergence in UK Between Pensioner Buyout Cost & Pensioner Funding Reserve Use of Buyout Option in UK & Rest of World, 2008 Experience in the US Value of pension assets fell by 23% in 2008 Extension of recovery period for DB plans multiemployer plans given 3 extra years Restrictions on lump sum distributions for < 80% funded: ½ benefits as lump sum for <60% funded: no benefits as lump sum Waiver of requirement for minimum distribution of DC plan benefits at age 70 1 / 2 6

7 Experience in Canada Value of pension assets fell by 19% in 2008 The allowable time for restoring full funding of DB plans has been extended from 7 to 10 years. Summary: Policies That Would Have Favoured Employees Policies which could have reduced effects of financial crisis on pension scheme members Note in accounting statements that pension plan volatility is an exceptional event that does not affect long-run profitability of firms Require DB schemes to over fund Make DB commitments a debt to employer Require DC schemes to give a minimum rate of return guarantee Summary of Actions Taken, DB Schemes 7

8 Summary: Overview of Actions Taken, DB Schemes Primary focus in all four countries has been on reducing benefits or employer costs not on preserving member benefits Range of policies used to reduce benefits widest in Ireland & US with largest exposures to equities Lack of pension protection fund in Ireland forced government to introduce State annuity for insolvent schemes Up to 80% DB schemes closed in UK and large companies now playing endgame in pension buy-out market For DB schemes in all four countries financial crisis has accentuated declining trend already well established Summary of Actions Taken, DC Schemes Summary: Overview of Actions Taken, DC Schemes DC schemes in Ireland & UK trying to support pension benefits by liability driven investment DC schemes in US trying to cut employer costs 8

9 Conclusions: Continuing Decline & Risk Shifting of DB Schemes Financial crisis has shown risks of DB plans much greater than realized & that they may be unable to deliver benefits promised Decline of DB schemes will continue (faster for small & medium size schemes) Employers desire to de-risk DB schemes may require design reforms to shift more risk to employees Conditional indexation linked to funding level as in the Netherlands Conclusions: DC Schemes Financial crisis has highlighted risk of inadequate benefits from DC plans Employers prefer light regulation of DC plans Trust in DC schemes may require a guaranteed minimum rate of return to smooth fluctuations in replacement rates Failure at national level to provide pension protection may require development of IORPs directive to set prudent investment rules for cross- border DC schemes to protect employees Contact us Gerard Hughes John Turner 9

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