Compromise usually comes one teaspoon at a time. One day you find yourself down the road and you don’t remember where you made a left turn.
So now we know what is in store for the Irish public ……..or do we? For the last few weeks the Irish Finance Minister has looked like a guy running around in a frying pan. It would now seem that all has been settled and the Irish people can relax in the knowledge that the rescue package has been passed by the government and approved by the EU and IMF. On closer inspection however, not all is as it may appear.
Irish banks have developed a reputation of being like the Bermuda Triangle in that money keeps disappearing when it goes in there. In the first instance the banks were guilty of using property as a piggybank; unfortunately it now looks like the government may be about to do something similar with the national pension reserve.
The National Pension Reserve Fund
The National Pension Reserve Fund (NPRF) of Ireland was set up in April 2001 with a specific mandate to fund the costs of future social welfare and public service pensions. With the proportion of Irish workers to pensioners projected to fall from five-to-one to two-to-one by the middle of the century, the creation of such a fund had been a significant undertaking for the government. The date of the first pension drawdown from the fund is scheduled for 2025.
The fund was launched officially with approximately €6 billion from the proceeds of the flotation of the state owned telecoms company Eircom, along with a commitment from the government to add at least 1 per cent of gross national product to its coffers each year. The 2010 third quarter results of the NPRF show that there is currently €24.5bn of assets held in the fund, which have subsequently been divided into two parts. The first part of the fund called the ‘discretionary portfolio’ is worth €17.9bn and is invested in a range of equities, bonds and alternative assets: http://www.nprf.ie/Performance/performance3Qtr10.htm
The second part of the fund totaling €6.6bn has been invested in a ‘directed portfolio’ comprised of preference shares and ordinary shares in the Bank of Ireland and Allied Irish Banks (AIB). This action was facilitated through the passing of emergency legislation during 2009 by the Irish Government and is invested in the banks at the behest of the Minister for Finance. These investments will remain part of the pension reserve, with any income generating from them being accrued to the fund.
The National Recovery Plan
The ongoing financial crisis and present high yields on Irish bonds have curtailed the State’s ability to borrow and forced it ‘cap in hand’ to the EU and IMF for support. The argument put forward by the government is that this external aid is needed to pay for key public services for Irish citizens and to provide a functioning banking system that will support economic activity.
A package in the region of €85bn is to be assembled with a view to helping the country structure its finances. Of this, €35bn will be used to support the banking system, with €10bn earmarked for the immediate recapitalization of AIB in order to bring the bank up to regulatory capital levels, and €25bn to be made available on a contingency basis.
In a prime example of how to ‘borrow from Peter to pay Paul’ the Irish Government has agreed to make a contribution to the €85bn facility with an injection of some €17.5bn from the NPRF. As a result, the extent of the external assistance required will be reduced to €67.5bn.
The €17.5bn funding has been secured by the government through the introduction of a new piece of legislation called the ‘Credit Institutions (Stabilization) Bill’, which also permits the restructuring of AIB as a non-listed financial institution using cash from the pension reserve
Investment Policy of the NPRF
A pension fund has to be adaptable and flexible so that it can react to conditions on the ground. In the light of the current economic and political climate, the task for the NPRF is to position the reserve fund assets in such a way that it serves the interests of all stakeholders.
In addition to its obligations to Irish banks under the ‘Credit Institutions Bill’, the NPRF is being allowed to invest in domestic sovereign debt. Up until now the majority of Irish bonds have been held by overseas investors, which therein results in an outflow of money from the State in the form of annual coupon payments. This new investment policy would assist the Irish Exchequer in bringing these assets back home and investing them in the local economy.
A sovereign bond, linked to the consumer price index, is to be created in 2011 for both pension schemes and insurers. To this end the government proposed the launch of a four-year ‘solidarity’ bond which pays an annual fixed rate of 1% with added bonuses of up to 50%, provided pension funds are invested for a longer time. The bond has a similar structure to the ten-year bond, paying a coupon each year and a bonus for investors who hold it to maturity.
The government has also decided to take the opportunity to shore up the country’s poor infrastructure by directing the NPRF to invest in this particular asset class. Investment in infrastructure is an attractive proposition for pension funds as it provides a good hedge for inflation, and can generate stable and long term income. It may also be used to promote projects that spur job creation, and invest in renewable energies such as the development of water and waste management systems.
The shift in investment policy enabling the pension reserve to invest in Irish debt runs the risk of the NRPF becoming the sole buyer of the country’s bonds in the foreseeable future should private pension schemes not be enticed to participate. Irish schemes may decide to shun such a move for fear of the risk of Ireland defaulting on its sovereign debt.
An additional point of concern is that the existing €24.5bn of funds accumulated in the NPRF is in itself not sufficient to cover the estimated pension liabilities in both the public sector and the state pension; recent estimates suggest that the current requirement for a fully funded pension is €116bn. The assets held in the NPRF were the only pre-funding that existed to cover pension liabilities. Under the latest reform and recapitalization of AIB this figure may be reduced significantly; the pension drawdown date of 2025 beckons!
Sooner or later the crisis-haunted financial merry-go-round will come to a halt. There are however only a limited number or rides available on the carousel. When the music stops…..it may be the pensioners who are left standing.