The great pension double standard

22 May 2011 By Kathleen Barrington

I vividly recall my first lunch at Irish Life, more than 20 years ago. The management team invited business journalists to join them in their private dining room following the publication of the company’s results.

The lunch was served by waitresses dressed in black and white maids’ outfits, while a butler served wine from crystal decanters.

I wondered briefly, at the time, about the impact the cost of Irish Life’s swanky head office would have on overall pension performance.

It is a question I’m now wondering about again, as I consider the impact that high pension fund charges are having on the performance of Irish pension funds.

It was good to see the pensions industry finally coming clean on the dramatic impact that the charges can have over the lifetime of a fund, even if the industry’s motive was to embarrass the government over its new pensions levy.

We now know that a 0.6 per cent annual levy on pension schemes could result in a 21 per cent fall in the value of private pension funds if it were to be continued over the lifetime of the fund.

Even if you are hostile to the pension levy, you can’t help noticing how loudly the industry is willing to shout about the impact of a 0.6 per cent tax on the value of pension schemes, while it is generally silent on the question of the impact that its own (often higher) charges have on pension outcomes.

For the reality is that Irish pension fund charges are high by international standards, and that the high cost of charges here impacts on the performance of pension funds.

In the case of Personal Retirement Savings Accounts (PRSAs), for example, some pension managers charge 5 per cent of every contribution plus a 1 per cent management fee.

So when you contribute €100 to your PRSA, the fund manager swipes €5.95, leaving you with just €94.05 of your original €100 investment.

The fund manager would have to deliver a return of almost 7 per cent when he invested that €94.05 just to give you back your original €100, never mind to increase it.

Industry sources argue that the PRSAs are expensive due to regulatory costs, and that charges for the management of other kinds of pension funds can be as low as 0.25per cent for certain schemes.

But research carried out by Aidan Mahon, a postgraduate student at the Waterford Institute of Technology (WIT), found that industry charges swallowed up a staggering 26 per cent of the total pot of retirement income over the lifetime of a pension in private sector schemes.

Mahon didn’t have a raft of PR advisers to promote his findings on radio, television and in the print media, which meant that his work didn’t get the media and political scrutiny it deserved, although it was mentioned in this newspaper and in the Irish Independent.

It is worth repeating some of Mahon’s key findings, including the fact that charges borne by the smallest schemes represent 3.64 per cent of assets while the charges borne by the larger schemes represent only 0.32 per cent of assets.

The difference that these charges make to the final pension pot available for retirees is absolutely enormous.

Mahon found that, for a small Irish pension scheme with just 36 members, charges would lead to a reduction in the retirement pot of almost 76 per cent.

He reckoned that each member of the 36-person pension scheme forked out about €2,000 in charges each year.

By contrast, the members of the larger schemes faced only a relatively modest reduction in their retirement pot of just 6.67 per cent due to charges. Mahon calculated that the members of the larger schemes typically shelled out about €175 in charges each year.

The greater charges carried by members of smaller schemes make a huge difference to the pension pot available because funds that would otherwise have been invested on behalf of the member are instead swallowed up in charges.

Mahon recommended that smaller occupational pension schemes should be merged, to allow them to gain the efficiencies associated with economies of scale. The case for consolidation of pension schemes was particularly strong for some semi-state bodies because they had similar pension scheme arrangements.

He also recommended that service providers should be required to report costs in a standardised broken-down manner which illustrated the effect of charges on the overall pension fund; and that a study should be carried out to compare pension costs across countries.

The charging structures of Irish pension funds are notoriously opaque, giving rise to problems comparing charges across pension providers. But Mahon cited research that suggested that Irish pension fund charges were substantially higher than elsewhere.

For instance, the mean percentage of assets absorbed by fees in Ireland amounted to 1.25 per cent compared with 1.08 per cent in Australia and between 0.2 and 0.9 per cent in the United States.

The Green Paper on Pensions published in 2007 also noted the impact that charges had on the performance of Irish pension funds and the opacity of the pension fund charging structures.

The returns recorded by the pensions industry in recent years have been very poor due to a combination of high charges, falling interest rates, improved longevity and poor pension fund performance.

Irish pension funds were the worst-performing in the world in 2008, the year of the financial crash, as they were over-exposed to shares and property, according to an OECD report.

In short, we appear to be paying our pension managers more money for inferior performance.

The Pensions Board had been leaning on employers to contribute more to their pension schemes in recent years, in an effort to plug the very big deficits in many of the country’s pension schemes.

Many employers contributed very generously in an effort to meet the promises they made to their employees. Now, those employers can only look on in horror as the government swipes some of the money that was intended to fill pension fund holes.

Against that background, it is unlikely that employers will be willing to contribute more to their pension funds, making it highly probable that the promised benefits to pensioners will have to be cut. It would be far preferable if the pensions industry started by cutting its own costs before eating into its customers’ pension funds.

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