OECD publishes Review of the Irish Pension System
The OECD has published its Review of the Irish Pension System.
The report provides an international perspective on Ireland’s retirement income provision, the result of a request from the Minister for Social Protection for a focused review on the viability and long-term impact of proposed changes in pension policy, taking into account the impact of the economic downturn. It covers all components of the pension system: state, private personal and occupational plans and schemes for public-sector employees.
Four significant objectives are examined:
- the sustainability of the pension system in the context of the challenges of demographic change and financial-market risk;
- the adequacy of future retirement incomes and, in particular, the impact of private pensions;
- the modernity of pension provision to ensure that it reflects social and economic changes, especially the support it can provide for flexibility in the labour market and extending working lives; and
- equity within the pension system between different groups: women and men, low and high earners and workers in different sectors of the economy.
The report includes a summary of the main recommendations for reform of pensions grouped under the categories set out below. Some of the key recommendations under these categories are also included below:
Parametric changes in the State pension system
- The long-term retirement age, which at 68 is relatively high in international comparison, could be linked to life expectancy after 2028 in order to ensure that improvements in life expectancy do not significantly extend the duration of retirement.
Structural reform of the State pension system
- The report describes three options for a structural reform of the State pension scheme. The Executive Summary outlines the options which the OECD considers to be best, which are: a universal basic pension or a means-tested basic pension. The authors comment that both of these options would have the advantage, compared with the existing scheme, of introducing a much simpler, more transparent and less costly public pension scheme.
Reform of the public service pension scheme
- At a minimum, a faster phase-in of the new rules of the occupational scheme for public servants should be considered; this would entail including existing public servants in the new scheme based either on a certain cut-off age or on length of service.
- Any new private pension scheme for private sector workers should also be extended to public servants, at a minimum for new entrants but ideally also for some of the existing public servants.
Policy options to expand private pensions coverage and retirement savings
- To increase adequacy of pensions in Ireland, there is a need to increase coverage in funded pensions. Increasing coverage can be achieved through 1) compulsion, 2) soft-compulsion, automatic enrolment, and/or 3) improving the existing financial incentives.
- Compulsion, according to international experience, is the less costly and most effective approach to increase coverage of private pensions (OECD Pensions Outlook, 2012, Chapter 4).
- The authors believe that there is a misalignment to correct between the existing tax deferral structure in Ireland, which provides higher incentives to high-income earners, and the policy goal of increasing coverage, especially for middle to low-income people.
- International evidence (Germany, Australia, and New Zealand) suggests that flat subsidies and matching contributions increase incentives to save for retirement for middle to low incomes.
Improve the design of DC arrangements
- The design and institutional set-up of DC pension plans need to improve in line with the OECD Roadmap for the Good Design of DC Pension Plans.
- Establish appropriate default investment strategies, while also providing choice between investment options.
- Establish default life-cycle investment strategies as a default option to protect those close to retirement against extreme negative outcomes.
- Encourage annuitisation as a protection against longevity risk. For example, a combination of programmed withdrawals with a deferred life annuity (e.g. starting payments at age 85) could be an appropriate default.
- While still keeping the principle of pension savings being “locked away”, the Irish Government could consider allowing withdrawals strictly only in the event of significant financial hardship.
Enhancing benefit security in DB schemes
- Strengthen the Irish legislation regarding the protection of DB plan members when plans wind up. For example, healthy plan sponsors should not be allowed to “walk away” from DB plans unless assets cover 90% of pension liabilities. This funding requirement would introduce some type of guarantees for members and it would allow at the same time some degree of risk sharing. The funding ratio should be calculated following prudent standard actuarial valuations. Moreover, the priority currently given to pensioners before other members if a scheme closes because of sponsor bankruptcy should be eliminated.
- Further legal reforms may be needed to introduce more flexible DB plans that for instance allow for accrued benefits to be cut in case of underfunding (e.g. the Netherlands) and, more generally, for risks to be shared between plan members and pensioners, as well as plan sponsors.
- Revise the new funding standards as they may create new risks for pensioners by offering strong incentive for pension funds to invest in government bonds, in particular sovereign annuities.