In his Budget speech in 1999, Finance Minister Charlie McCreevy alluded to the ‘great interest’ shown in his reform of pension arrangements for the self employed and proprietary directors, and declared ‘I am not finished with this area yet’.
So we await with bated breath his pronouncements on this issue when he rises to deliver his Budget speech on December 6th.
The smart money favours the application of the Approved Retirement Fund (ARF) regime to ordinary members of occupational pension schemes, a development that could have enormous implications for the pensions sector and, by extension, to the broader financial services industry.
An initial concern for the industry might be how these new-found freedoms will affect the behaviour of retirees. If people are allowed take a substantial part of their pension in lump sums, will this directly reduce the industry’s funds under management?
A good precedent for this type of change was set in Australia, where the reaction of some pensioners to their freedom of choice was to choose to behave irresponsibly. In the first days of liberalisation, new cars, new houses, and even new yachts figured in some of the more profligate uses found for the accumulated wealth of pension funds.
The evidence from Oz since then, however, has been more encouraging. A 1997 survey of almost a quarter million people aged 45 or over, who had received lump sums retirement funds or were due to claim one, found that 60 per cent favoured rolling over within the same fund, investing the money, or buying a pension annuity.
Another 14 per cent paid off their mortgage or bought a new home; 5 per cent paid off outstanding debt; 4 per cent paid for a holiday or helped family members, and 3 per cent bought a new car. One tenth of the survey were ‘undecided’ as to how to use their funds
.
Further research, again in Australia, found that the older people were on retirement, the more likely they were to invest their lump sum. Just over half of 45-54 year olds surveyed rolled over or invested their lump sum on retirement, but this rose to 68 per cent among those aged 65 or over. (The Australians have since tightened up on the age restrictions for claiming pension entitlements).
For the Irish insurance sector, this would indicate that there will be some ‘drift’ of funds away from traditional annuity options once Mr McCreevy extends the ARF freedoms to the occupational sector. But a wholesale flood of money out of the industry into consumer spending, family donations, or alternative investment options must seem unlikely.
A switch into alternative investment options is quite probable, and that should prove no bad thing for the industry. The attitude of most life assurance companies to annuities is ‘take it or leave it’. Only a few companies are willing to quote for this business, which is price competitive yet carries a growing longevity risk.
At the time of going to press, a quick straw poll of some Irish life offices shows that they don’t place a lot of value on this type of business and that the ARF move would be generally welcome. The ARF extension would continue to represent funds under management for the life companies going forward, generating management fees on the value of these funds each year into the future. Even when individuals die, perhaps one or two decades into their ARF, it is likely that there will be strong residual values in their funds and these funds are likely to remain within the investment system.
Those who elect not to buy annuities will probably seek alternative investment options, and our industry will have a clear role to play in helping people make informed decisions.
Information and education will prove of paramount importance in ensuring:
• that people are fully aware of the precise range choices available to them under ARF rules, and
• that they are enabled to decide how they allocate their pension asset without undue influence from any quarter, be that from their families, from independent financial advisers, or even from the pensions industry itself.
We still don’t know quite how much freedom will be allowed to individuals. Much of the dialogue surrounding the introduction of the ‘Stakeholder Pension’ in the UK has centred on the appeal of strict limits on drawdown rates, setting maximum and minimum levels that would curb profligacy and hoarding (for estate purposes). In effect, these rules will essentially dictate that the pension asset owner derives the optimum income possible for the size of the fund and the expected longevity of its owner.
The few hints available thus far suggest that Mr McCreevy’s faith in the market will not favour such legal restrictions, and this may put our industry in the position of educator (whether we like it or not). If this transpires, then all our dealings with the pension-owning public must be objective, fair, and totally transparent.
The possibility remains that the role of educator may be taken on by the State itself. The Australians have established a successful precedent for a government-sponsored Financial Information Service, whose officers provide independent advice to people ten or fifteen years off retirement.
As an industry, we would have nothing to fear from a similar development here. We share with the Government the common aim of having people plan responsibly and prudently for their post work lives, and if our products and services are up to scratch, an ARF type regime need only change how, not whether, we deal with occupational fund beneficiaries.
Des McGarry is managing director, of Invesco Pensions and Investment Consultants. Invesco has more than 300 corporate clients on its books and is particularly strongly represented in the IT, engineering, manufacturing, and services sectors. |
