Reform of priority order will ensure greater fairness in resolution of Defined Benefit pension scheme issues
The Minister for Social Protection, Joan Burton TD, has today (19th November 2013) secured Government approval for a package of measures aimed at tackling difficulties in Defined Benefit pension schemes.
The package addresses the situation where an underfunded Defined Benefit pension scheme winds up in deficit or elects to restructure. It can arise at present that pensioners receive all or almost all the pension fund and the members who have contributed but not retired receive considerably less than expected. These measures will ensure a more equal distribution of assets in an underfunded Defined Benefit scheme when an insolvency/restructuring occurs. The measures will apply only in a limited set of circumstances, meaning the potential number of schemes affected will be small. In those limited circumstances, the measures will ensure a fairer deal for employee and former employee members by increasing their future pension entitlements, while prioritising an occupational pension of up to €12,000 for existing pensioners in addition to their State pension entitlements.
The typical pensioner in such a scenario would have a State contributory pension of €12,000 in addition to their occupational pension, meaning they would therefore receive a retirement income of up to €24,000. Those pensioners receiving occupational benefits in excess of €12,000 will still retain a significant degree of prioritisation for receipt of benefits.
In the case of both a company and scheme being insolvent, the Government will guarantee that existing pensions will be protected to a level of 50% with pensions of €12,000 or less being 100% protected. Minister Burton has secured agreement with the Minister for Finance, Michael Noonan TD, to use funds from the Pension Levy to meet any obligations on the State that may occur arising from such double insolvencies.
The measures meet Ireland’s obligations under the EU Insolvency Directive to protect workers’ entitlements. They are also in keeping with the stated consensus among stakeholders – including employer representative bodies, trade unions, pension funds and actuaries - of the need for reform of the pensions priority order to ensure greater fairness within Defined Benefit scheme structures. Depending on the number of pensioners and the rate of pension in payment, every 1% redistributed from pensions in payment could result in a 2% or more increase for future pension entitlements for current and former employees.in the scheme.
Minister Burton said: “The measures I am announcing today are the result of very careful consideration of the issues affecting Defined Benefit pension schemes. These measures are about fairness in the first instance – to ensure that in the circumstances where there is an insolvency or restructuring of a Defined Benefit scheme, workers receive a greater share of their pension benefits to which they are contributing, while pensioners are protected to a high level to ensure adequate income in retirement.
“Crucially, the State pension is totally unaffected by today’s measures. I have fully protected the State pension since becoming Minister in light of its critical importance to older people. But not every employer has been in a situation to protect the Defined Benefit schemes they put in place for their workers. The State could not be expected to solve employers’ funding problems given the financial implications it would have for taxpayers. However, the State can intervene to ensure a fairer deal for workers and sufficient protection for pensioners while allowing employers to get to grips with their pension problems. That is the purpose of this Bill.”
These measures affect only the occupational element of a Defined Benefit scheme as follows:
i. When a pension scheme winds up in a situation where both the employer and the pension scheme are insolvent (Double Insolvency):
This change will ensure that all members in the pension scheme share some element of the deficit and that the assets in a scheme are distributed more fairly. The Government will ensure that existing pensions will be protected to a level of 50% with pensions of €12,000 or less being 100% protected. But all members will be expected to contribute to bring the benefit level of all scheme members up to 50%. If the pension scheme has insufficient funds to cover this amount, the State will fund the shortfall, using funds provided by the Pension Levy,[thereby guaranteeing existing pensioners their occupational pension up to a maximum of €12,000, or 50% if greater, and current workers 50% of their pension entitlement upon retirement]. Nothing in these measures will impact on State pension entitlements, which remain unaffected. [See Example 1 in Annex.]
ii. When a pension scheme winds up and is insolvent (Single Insolvency):
The way in which the scheme’s assets are divided up in a wind-up situation will change, with the current 100% priority for pensioners being reduced in a limited way. This will mean that higher-paid pensioners will contribute to improve the benefit levels of current workers. Lower-paid pensions (up to a maximum of €12,000) will not be reduced. Again, none of these measures will affect State pension entitlements. [See Example 2 in Annex.]
iii. When a pension scheme is restructuring:
The same option at (ii) above will be available to trustees when a pension scheme is restructuring to enable it to remain viable. This will support and encourage employers to keep their schemes open. [See Example 3 in Annex.]
Further strengthening of the regulatory structure is also being introduced to identify and prevent underfunding in pension schemes as early as possible. The regulatory changes are aimed at minimising the risk of future double insolvencies. However, if such cases arise in the future, the legislation lays out the template for dealing with such cases by ensuring workers’ entitlements will be protected to 50% in line with the EU Insolvency Directive.
Historic double insolvencies will not be covered by this legislation but are covered by the Insolvency Directive. This means that in those past cases, pensioners’ entitlements will not be affected in any way and they will continue to receive 100% of their pensions. However, as the Directive stipulates that workers should be protected to at least 49%, the State may use funds raised by the Pension Levy to explore options to resolve historic double insolvencies which failed to meet this requirement.
Minister Burton said: “Ultimately, these are employer-sponsored pension schemes. However, when schemes are underfunded and wind up, the outcomes may give rise to some serious imbalances. I want to reassure all members of schemes that these measures are being introduced to deal with a risk that may not happen. However, in a small number of cases where it might occur, the approach taken has been to ensure a balanced risk-sharing approach between all members, while protecting those with the lowest levels of pension. Therefore, all beneficiaries in the scheme contribute to addressing these difficulties.
“The package of proposals will build on previous reforms which I have made in this area, and provide a low-cost structure to the State of managing these issues over a long period of time. The proposals ensure that Ireland meets its commitments under the Insolvency Directive but at the lowest possible cost to the taxpayer.”
Legislation to implement these proposals will be enacted in the coming weeks.
ENDS
Notes to the Editor:
The Pensions [Amendment] Bill contains the following provision:
1. When the employer and the pension scheme are both insolvent (Double Insolvency):
When an employer goes out of business and the Defined Benefit pension scheme in that business is also underfunded, the funds in the pension scheme will be divided to ensure that all of the beneficiaries of the scheme (this includes pensioners, current employees and former employees who have not yet retired) receive 50% of their benefits. Existing Defined Benefit pensions in payment will be protected up to €12,000.
Where the Defined Benefit pension scheme doesn’t have sufficient monies to meet this amount, the State will provide the shortfall to the scheme, using Pension Levy funds
This addresses the current exposure of the State following the ruling of the European Court of Justice (ECJ) in April 2013 which stated that Ireland is in breach of the EU Insolvency Directive. The ECJ ruled that when both the employer and pension scheme are insolvent, the State must put measures in place to provide at least 49% of the pension benefits expected.
This measure provides for a fairer outcome for all members, gives protection to lower-paid pensioners and limits the extent to which the taxpayer has to contribute.
Other measures are being introduced in the legislation which are not a requirement under the Insolvency Directive but seek to minimise the likelihood of similar situations arising.
2. When the employer is still in business but the pension scheme is winding up (Single Insolvency):
In future when an underfunded pension scheme is winding up (and when the employer is in business), the existing 100%
priority being given to pension benefits is being changed to reduce the priority given to higher pensions. This will ensure that current employees and former employees (who are not yet retired) and who have also contributed to the pension scheme receive a greater share of the benefits.
It can arise at present that pensioners receive all or almost all the fund and the members who have contributed but not retired receive little or nothing.
Pensioners in receipt of pensions under €12,000 will receive first priority to ensure that they are not affected by this.
Pensions between €12,000 and €60,000 will be reduced by 10% of the total pension amount.
The overall reduction is limited to a maximum of 20% of the total pension amount where the pension is over €60,000.
The State is not contributing in this instance. The employer is still in business and it is the employer who sponsors the Defined Benefit pension scheme and makes the pension “promise”.
3. When a pension scheme is restructuring
The aim here is to ensure that Defined Benefit schemes can be supported to remain open and viable.
Trustees are being given the option to restructure a scheme to ensure the ongoing viability of the scheme. Pensioner benefits will be 100% protected up to €12,000 per annum or full pension if lower.
Trustees will then be provided with an option to reduce higher pension benefits (up to 10% of the total pension in payment when the benefit is between €12,000 and €60,000 and up to 20% of the total pension in payment when the benefit is in excess of €60,000) in order to make more funds available to the scheme for other scheme members.
4. Other changes to Regulations not included in the Bill but part of the overall package of measures
The Pensions Board will be introducing tighter regulation for Defined Benefit pension schemes. This entails:
· Refusing to accept funding proposals from schemes with less than 50% funding, forcing schemes to take actions to address their very poor funding situations.
· Imposing additional obligations to ensure significantly underfunded schemes achieve a base level of funding in the short term.
· Withdrawing flexibility options to schemes which go off track while subject to a recovery plan where the level of funding in that scheme falls below 50% level.
Annex 1 - Scenarios demonstrating the impact of the changes:
Double Insolvency (employer and pension scheme both insolvent):
John is a 67-year-old retired worker who has an occupational Defined Benefit pension of €14,000 from Company A and a State contributory pension of €12,000.
David is a 64-year-old who is approaching retirement in Company A when the company and the scheme enter insolvency. Under the existing priority order he may receive just a fraction of his promised pension of €14,000 upon retirement as the limited pension scheme assets could first be used up securing 100% of existing benefits for pensioners like John.
Both David and John’s State pension would be unaffected. Under the proposed changes to the priority order, as the pension scheme winds up, the assets will be distributed as follows:
i. Both David and John’s benefits will be secured at 50%. John’s pension will be secured at €7,000 (50%).
ii. Then John’s pension will be increased to €12,000.
iii. If the scheme has more funds, John’s pension will be further increased.
Note: If the scheme itself does not have sufficient funds to provide David with 50% of his expected benefits and John with €12,000 of his pension, the State will step in to make up the difference, using funds from the Pension Levy.
Note: As John still has his State pension, his overall pension benefits are €22,000.
Single Insolvency (Employer solvent, pension scheme insolvent):
Tracy is a 68-year-old who has an occupational Defined Benefit pension of €40,000 from Company B and a State contributory pension of €12,000.
Jill is a 36-year-old employee of Company B when the Defined Benefit pension scheme enters insolvency.
Up to now, Tracy would have continued to receive 100% of her occupational pension while Jill would have received whatever was left in the pension scheme after existing pensioners had received their 100%.
Under the proposed changes to the priority order, Tracy’s State pension would be unaffected and the first €12,000 of her occupational pension would also be protected. However, the remainder of the occupational pension would be reduced by €4,000 (10% of €40,000).
Reducing higher level pensions in payment in this manner in Company B will ensure improved funding is available to be distributed to current employees like Jill to ensure a fairer income upon retirement.
Again, if there are sufficient funds in the scheme, the reduction in pensions may be less as funds are distributed under the priority order.
Restructuring:
Brian is a 75-year-old who has an occupational Defined Benefit pension of €7,000 from Company C and a State contributory pension of €12,000.
Jimmy is a 55-year-old employee of Company C who is facing a reduced pension entitlement because the scheme is underfunded.
Availing of the measures outlined above, Company C restructures its scheme.
Brian’s occupational pension falls beneath the €12,000 threshold at which redistribution would kick in, and so his €7,000 pension is fully protected, as is his State pension of €12,000.
Company C redistributes some of the assets being used to pay higher-paid pensioners in the company above €12,000 to ensure a fairer level of benefits will be available for Jimmy when he retires. The pension scheme remains viable and could, depending on its investment performance in the future, restore additional benefits for Jimmy.
In another scenario, Company D has a high number of pensioners with average pensions of €25,000.
The pension fund is underfunded. The trustees are able to determine that a 5% reduction in pensioner benefits can be redistributed to the current employees and increase the employees’ expected benefits by approximately 15%.
Note: Where a scheme has many pensioners, a small reduction in pension benefits can increase assets in the scheme by a considerable amount. Trustees will have discretion as to level of reduction up to the limits in the legislation.