Most pension schemes with multiple members invest through investment vehicles, such as an insurance company or other unit-linked funds. The entire pension assets may be placed with an insurance company which provides all services in a single package. In this case, the immediate investment may be made in the insurer’s managed funds. There may be several layers of funds and sub-funds. The investments may be made in funds which are themselves managed by other providers.
Larger schemes, typically only those with assets in excess of €15 million, may choose to invest directly in assets such as shares, property, government bonds and cash. In larger schemes which invest directly, the trustees acquire the investment assets. They are usually held by a third-party custodian as a nominee holder. Certain smaller self-managed pension schemes (SSAPs) may choose to invest directly in assets but are subject to certain investment controls.
Even where there are powers of direct investment, the trustees themselves will not generally have the competence to undertake the requisite investment, so as to meet the liabilities of the scheme. In practice, almost all pension trustees retain investment managers and advisers where direct investment is undertaken.
Pension and Insurance
Most occupational pension investment takes place through life assurance companies. Historically, many insured pension benefits afforded a full or partial guarantee of the pension level, regardless of investment risk. Mortality risks were in effect spread between individual scheme members.
The bulk of occupational pension benefits are no longer risk based but constitute investments made through policies or funds which seek to build up assets sufficient to meet the pension liabilities of the particular pension beneficiary. A (notional) individualised account or fund (invested collectively) accrues, from which pension benefits are purchased on retirement. An annuity is usually purchased at retirement, which subject to guaranteed elements, involves an element of mortality risk sharing at that point.
Insurers as Pensions Service Providers
Insurance companies are one of the principal providers of pension and investment services. Although better known for providing risk cover, most pension insurance products are entirely or principally of an investment nature. They may also have elements linked to mortality and life event risks. Until recent decades, insurance-based investment was provided through policies, deferred annuities and with-profits policies, which had a greater risk element.
Life insurance companies commonly provide full administration services for pension schemes, including documentary, regulatory compliance and investment services. They may undertake the administration of the pension scheme, as a separate service. They will provide the relevant documentation and comply with taxation and regulatory requirements in these cases.
The charges for the insurer’s pensions services may be built into their fee and commission structure. The cost may be expressed as a fee and / or a there may be elements of commission built into unit prices.
Older Style Insurance Investment
Older insurance policies typically guarantee a particular pension on retirement. There may be a deferred annuity which guarantees to provide a pension of a specific level, at a particular (retirement) age. The guaranteed proportion is partly risk-based, in that the “risk” of prolonged survival is shared across policyholders under these arrangements.
In the case of “with profits” policy investment, where the return of investments so justifies, an annual bonus may be declared from surplus investments and added to the pension policy. Profits are not deducted once added. The objective is to build up the fund over a prolonged period. There is a relatively smooth, but modest, buildup of investments. Typically, the policy grows conservatively over time.
The insurance company may retain reserves where there is a good return on investments in a particular year and not add them in full or at all to the pension policy / fund. Conversely, it may add a bonus to the policy / fund from its reserves, where there is poorer than normal investment return in a later year. The relationship between the bonus added and the investment return is usually at the life company’s discretion.
Under these older arrangements, there is a more limited degree of exposure by the pension holder to the underlying assets, in which investment is made than is the case under more modern arrangements. In one sense, the life company takes a higher degree of risk, but effectively charges for so doing.
The pension holder is likely to enjoy a return less than that on the underlying investment portfolio. The policy value is not directly linked to the underlying investment performance. The insurance company may declare a bonus on its underlying investments or hold them in reserve.
Pooled Insurance Investment
The more modern investment approach involves direct investment in the insurer’s unit-linked funds. In this case, there is no element of guarantee by the insurance company. The fund’s value reflects the underlying investments and the investment returns on the underlying funds. The funds are pooled investments. They may be invested ultimately, in a particular asset type or in a particular split or balance of asset types.
The investment through a unit-linked fund provides a more direct link between the value of the underlying investments and the value of the relevant pension fund. The unit linked policy reflects the value of the underlying pool of assets / investments. There is unlikely to be any element of guarantee by the insurer.
The essence of the unit-linked fund, whether maintained by a life assurance company, a unit trust or other provider, is the facility to purchase units in particular types of funds, with a specific asset balance and makeup. The units are like shares in a company and give the equivalent of economic ownership of part of the underlying investments held by the underlying fund.
The insurance company or investment bank charges commission in relation to the funds. This is reflected in the difference between the bid and offer price on the units in each fund. There may be initial set-up costs to the policy as well as periodic investment and other charges.
Unit Linked Funds and Unit Trusts / Funds
Pension assets may be invested in a unit-linked insurance policy which is invested in internally constituted pooled funds. From the legal perspective, the life insurance company does not, in fact, hold the units as separate assets, in contrast to the position with “true” unit trust fund providers. The link is notional. Unlike open-ended investment funds, there is not usually an ongoing undertaking to redeem units on demand.
Less commonly, pension assets may invest directly in unit trusts and investment funds, which are not managed by an insurance company, but by another financial service provider. Unit trusts, or more commonly, shares in investment funds/ companies are similar in substance, but not in legal form to unit-linked funds operated by life insurance providers.
Pension assets may, of course, be indirectly invested in unit trusts and investment funds through the investments of the unit-linked policy. Each is an intermediary. There may be multiple layers of investment entities and vehicles between the pensions and the investment asset.
A broadly similar type of taxation regime applies to unit trusts / funds and life assurance unit linked funds / policies. There is a complete exemption from tax on investments within the fund. Pension vehicles enjoy an exemption from the encashment tax that applies to non-pension investors.
Each fund into which the pension is invested may have a pre-defined allocation of assets, based on risk, geographical spread, industry sector, etc. The fund investment may be spread between various asset classes. The investment strategy of the pension scheme may be varied by reallocation of its investment in the relevant underlying funds. The change or adjustment may be depending on economic considerations and the liabilities of the schemes, in terms of present and future pension obligations.
As it is assumed to be difficult / impossible to beat the market average on an ongoing basis, a passive investment strategy may be undertaken in one or more funds representing aa broad cross section of the securities market. The composition may be based on a market index. The lower costs of a passive investment strategy are commonly believed to outweigh the costs of a more managed fund, both in terms of management fees and the costs of switching investments.
Investment theory suggests that the optimum desired balance of risk and return can be achieved by choosing a particular basket of risky, safe, liquid and illiquid assets at the outset, and by maintaining and rebalancing it over time.
Typically, the weighting of risk to return is greater when the pension holder is further from pension age. As the pensioner reaches retirement age, the share of risk assets should reduce. In the case of a multi-member scheme, this broad principle will apply to the weighted age of the body of members collectively.
Risk Management and Matching
The underlying profile of the invested asset must reflect the liabilities of the fund. The liabilities will depend on the nature of the pension promise and age profile of the beneficiary. As a greater proportion of pensions come closer to payment, it is generally assumed appropriate to reduce the extent to which investments are held in riskier assets and to increase investment in cash and cash-like assets.
The riskiness of assets must be appropriate. The riskier the portfolio, the greater the variation in likely return. Generally, a more prudent approach is appropriate, although some element of risk is necessary in order to achieve reasonable returns.
The diversification of assets within classes and between classes generally, is assumed to reduce risk. The concentration of investments in particular businesses or sectors poses a risk of vulnerability to that sector. The requirement for diversification means that it is uneconomic for anything but larger funds to self-invest.
Investments in assets denominated in other currencies may be mismatched with domestic pension obligations, which will usually be in Euro. In principle, it is possible to hedge such risks. Hedging may cover a wide range of risks relative to particular asset classes. The Euro has reduced foreign-exchange risk in pension investment. In principle, it enables pension trustees to invest in a wide range of Euro denominated assets, without any apparent significant risk of devaluation.
The general rule is that borrowing is permitted for liquidity purposes on a temporary basis only. There is an exception to the general restriction on borrowing for a single-member scheme. This exception allows small self-directed single-member schemes to invest in particular assets, such as property and borrow for that purpose, subject to Revenue conditions and restrictions.
Direct Investment with Insurer or Managed Fund
In one sense, all occupational schemes invest directly. However, most do so exclusively through unitised funds. They invest all or part of the scheme assets through a life insurance company as an investment intermediary. They may also invest through other intermediaries such as stockbrokers, financial institutions, professional investment managers.
The trustees of most smaller schemes and many medium and larger schemes in effect outsource most or all of the scheme investment, by investing into insurers’ or other regulated providers’ funds and services. The insurer or other entity may provide a packaged service, by which most pension activity is outsourced to it. There may be differing levels of input by the trustees in broad investment selection.
In other cases, with “true” direct investment, the scheme assets may include a combination of direct investments and collective investment instruments, such as policies with unitised funds and unit trusts / investment funds. The degree of managed or passive investment will depend in the particular fund, and the contract entered with the insurer or other intermediary.
Where the pension trustees invest directly, other than through an insurer or other regulated provider, the trustees will usually appoint an investment manager to deal with the investments of the scheme. The trustees may impose terms and conditions on the investments or may give the investment manager considerable discretion.
There should be a written appointment incorporating the terms of the agreement. The investment objectives should be set out. The level of discretion afforded to the investment manager should be provided. The investment manager will be responsible for making investment decisions in accordance with the agreement.
The pension trustees may set the parameters of investment under the agreement. This may include a broad indication of the desired type of assets mix, liquidity and risk. Investment funds typically follow industry benchmarks in relation to the asset class weighting and the type of investments made. The extent of the investment manager’s professional duty of care will be less where the trustees reserve a greater input. It may be limited in any event by the terms of the agreement.
The scheme assets may be held by a custodian who is nominee holder of the pension assets. Custodians commonly hold assets, in larger schemes. The custodian must keep the assets separately and ensure that the investments are made in accordance with the terms of the pension trust and mandates.
The custodian should be an independent regulated body, with a strong credit rating. It holds the assets but does not make investment decisions. The custodian may be appointed to ensure compliance with the rules of the trust and/or the terms of the investment management arrangement. It acts as guardians to ensure that the rules of the trust are followed.
There are various pieces of financial services legislation and rules which are designed to protect investors. Life insurance companies and investment funds are highly regulated so as to ensure their solvency. Their funds are segregated and are not available to their creditors or for use for other classes of insurance business. Investment advisers and intermediaries, whether insurers or others are also regulated in relation to their competence and the conduct of their business.
An annuity provides a pension for life or another period, based on the fund available to purchase it. The level of income that can be purchased by the annuity depends on the annuity rate available at the time. The income is taxable income and tax is deducted under PAYE.
Annuity rates are determined by life assurance companies having regard to the age and sex of the person concerned and the general level of interest rates. The lower the annuity rate, the higher the amount required to purchase the annuity for a given level of income.
The annuity may be payable for the life of the pension beneficiary. The annuity will commonly provide for an annuity for the pensioner with a reduced annuity upon the pensioner’s death for his spouse and perhaps children. The cost of this annuity is, of course, more expensive, for the same level of benefit.
Annuities can be bought with a guarantee of payment for a period, regardless of the pensioner’s death. An annuity with a guarantee, for example, for a certain minimum period of five or ten years, has a higher cost for the same level of benefit, so that a higher level of fund is required.
Annuities may be deferred when a person leaves a pension scheme for payment of a pension at a future date. A buyout fund is a transfer of monies out of a pension scheme to a policy.
In the case of a large scheme the trustees may be able, not buy an annuity, but to pay the pension out of the fund. Actuarial advice would be required for the requisite funding
Since 1999, the purchase of an annuity has not been mandatory for some pension holders. An approved retirement fund is available as an alternative. The ARF is beneficially owned by the pension holder. The holder may draw it as his discretion. Tax is payable on drawdowns. The tax must be withheld by the provider. There are tax incentives to leave funds in the ARF as they accumulate tax-free within it.
As originally enacted, Approved Retirement Funds, were available only to personal pension holders, PRSAs and certain proprietary directors of companies which operated occupational pension schemes. The Finance Act 2011 permitted members of defined contribution occupational pension schemes, to establish and to take pension funds into an ARF.
Annuities are provided by life insurance companies. An ARF may be provided by a wider range of providers. Qualifying fund managers may be insurance companies, banks, building societies, credit unions, collective investment undertakings, stockbrokers or investment firms. They must register with the Revenue Commissioners in order to provide ARF and AMRF services. Funds may be moved between ARF providers.
References and Sources
Irish Pensions Law & Practice Buggy, Finucane & Tighe 2nd Ed (2005) Ch.11
Pensions; Revenue Law and Practice (ITI) Dolan, Murray, Reynolds, McLoughlin (2013)
Trustee Handbook the Pensions Authority 5th Ed 2016
Statutory Guidance the Pensions Authority (Various)
Pensions Law Handbook 12 Ed Nabarro Nathanson Bloomsbury
Corporate Insolvency 6e: Employment & Pension Rights (6th Revised edition)
Occupational Pensions (Subscription) Lexis Nexis
Pensions Law and Practice with Precedents (Subscription) Sweet & Maxwell
Sweet & Maxwell’s Law of Pension Schemes (Subscription)
The Guide for Pension Trustees World Economics Ltd
The Guide for Pension Trustees website, you can:
Tolley’s Pensions Law Loose-leaf Service (Subscription)
Pensions Act, 1990
Pensions (Amendment) Act, 1996
Pensions (Amendment) Act, 2002
Pensions (Amendment) Act, 2006
Social Welfare and Pensions Act, 2005 (Part 3)
Social Welfare Reform and Pensions Act 2006
Social Welfare and Pensions Act 2007
Social Welfare and Pensions Act 2008
Social Welfare (Miscellaneous Provisions) Act 2008
Social Welfare and Pensions Act 2009
Social Welfare and Pensions (No. 2) Act 2009
Social Welfare (Miscellaneous Provisions) Act 2010
Social Welfare and Pensions Act 2010
Social Welfare and Pensions Act 2011
Social Welfare and Pensions Act 2012
Social Welfare and Pensions (Miscellaneous Provisions) Act 2013
Social Welfare and Pensions Act 2013
Social Welfare and Pensions (No. 2) Act 2013 49/2013
Social Welfare and Pensions Act 2014
Social Welfare and Pensions (No. 2) Act 2014 41/2014
Social Welfare (Miscellaneous Provisions) Act 2015 12/2015
Social Welfare and Pensions Act 2015 (Part 3)