Pensions regime promotes de-risking
30 July 2012
LEGAL UPDATE: THE LAST couple of months have seen significant developments in the regulation of defined benefit pension schemes in Ireland.
The Social Welfare and Pensions Act 2012 saw the introduction of a new requirement whereby such schemes must hold a risk reserve, in addition to meeting the existing solvency standard prescribed by the Pensions Act. The Pensions Board has also published their new funding standard guidance for defined benefit schemes.
This guidance saw the restoration of the statutory minimum funding standard (MFS) which had been suspended since 2008. As a result, underfunded schemes are now working on funding proposals to deal with their deficits. In most cases, the deadline for the submission of those proposals will be December 31st.
While the full effects of the new risk-reserving regime were signalled to apply only from 2016 onwards, any scheme whose funding proposal extends beyond that date must factor compliance with that new requirement.
In broad terms, the risk reserve must represent 15 per cent of the MFS liabilities, less the scheme’s holdings of EU government bonds or cash. In other words, the greater a scheme’s weighting in EU government bonds or cash, the lower the level of the risk reserve it is required to maintain. The impact a 0.5 per cent drop in interest rates would have on assets and liabilities must also be factored into the risk reserve.
The difficulty that arises is that only investments that are designated as secure bond investments under the new regime are euro zone government bonds.
This aspect of the new regime raises difficult issues for trustees from an investment perspective. Trustees are legally required to invest scheme assets prudently. In light of those obligations, trustees may be more comfortable investing in assets which are viewed as having a lower credit risk such as UK gilts, US treasury bonds or investment grade corporate bonds. However, the incentive to make such investments is diminished as doing so does not reduce the level of risk reserve which must be maintained.
The Minister for Social Protection has the power to prescribe other assets that offer “a similar degree of security” to EU government bonds. It is open, therefore, to the Minister to expand the range of secure investments for which schemes could get credit against their risk reserves.
The new regime seeks to encourage trustees to de-risk their investment portfolios. However, it does not incentivise them to consider a full range of possible investments. An appropriately diversified portfolio may serve to de-risk schemes as effectively as, or more effectively than, a pure euro zone government bond portfolio.
The Minister’s intervention to expand the class of bond investments would still achieve the stated regulatory policy objectives behind its introduction; namely, to protect against investment volatility and to encourage more prudent investment of pension assets.
Back to News