A. Introduction

56. The likely long–term evolution of pension outlays in Ireland has been assessed in two recently issued reports—Securing Retirement Income, prepared by the Pensions Board and the Interim Report to the Minister for Finance, prepared by the Commission on Public Service Pensions. The report of the Pension Board, which was prepared in the context of a national initiative aimed at elaborating a strategy for ensuring a fully–developed national pension system, included an assessment of the long–term sustainability of the social welfare old–age pension system. The Interim Report, by contrast, focused narrowly on the long–term outlook of the public service pension schemes.³⁰

57. The reports suggest that in the long run the financing requirements of the pension schemes would increase significantly: by the year 2046 total public spending on pensions could be as high as 10 percent of GNP, which would lead (in the absence of any changes in financing arrangements) to a financing gap of about 7 percent of GNP. The increase in the old–age dependency ratio is projected to boost expenditures on social welfare pensions by the beginning of the second decade of the next century, while the increase in the cost of public service pensions will begin earlier. Each report independently concluded that advance funding arrangements would help to smooth the financing of pension outlays over time.

58. Section B gives a brief overview of the old–age pension system in Ireland. Section C outlines the findings and recommendations of the Pension Board Report regarding the long–term costs of social welfare old–age pensions. Section D reviews the outlook for the long–term liabilities of the government with respect to the public sector pension schemes.

B. An Overview of Ireland’s Pension System

59. The old–age pension system in Ireland is essentially a two–pillar system. The first pillar is the social welfare system, while the second consists of voluntary supplementary pensions (mostly occupational). The social welfare pension system—an unfunded, pay–as–you–go scheme—provides contributory and noncontributory benefits. Contributory pensions are paid to those who qualify on the basis of pay–related social insurance (PRSI) contributions, while noncontributory pensions are means–tested benefits for those who do not qualify for PRSI contributions. Contributory pensions are paid irrespective of other income, and an individual over age 66 can receive the benefit even if employed. Although there is no formal indexation commitment, social welfare pensions are adjusted annually to reflect at a minimum price inflation; usually, the increase in pensions is close to the increase in average industrial earnings—over the period from the mid–1980s to 1998 social welfare pensions rose by about 95 percent of the increase in average annual industrial earnings. Since June 1998 the contributory pension has been IR£83 per week, which is about 29 percent of gross average industrial earnings.³¹ The weekly cash pension is augmented by in–kind benefits, which on average raise the pension level by about 14½ percent.³²

60. Currently, almost 90 percent of individuals over 66 years of age receive social welfare pensions, of which 58 percent draw contributory benefits. It is expected that the share of those entitled to contributory benefits will increase to 86 percent in 2016, owing primarily to the increased female participation in the labor force.

61. Occupational pension schemes can be grouped into unfunded public service schemes, covering civil servants, the defense and security forces, teachers, and health workers; privately funded occupational schemes, covering private sector employees and those working for commercial state bodies; and individual personal pensions, usually arranged by self–employed individuals. Occupational schemes are voluntary—employers are not legally obliged to provide occupational pensions.³³ The coverage rate, at about 46 percent of total employment, is not high and is gradually declining, owing to the surge in the number of people working part–time or on a temporary basis.³⁴ The tabulation below illustrates the sectoral breakdown of people covered by supplementary pensions:

Composition of People at Work Covered by Occupational and Personal Pensions

Source: The Pensions Board, “Securing Retirement Income,” May 1998.

Composition of People at Work Covered by Occupational and Personal Pensions

		Employment by category	Pension coverage
		(In percent of total employment)	(In percent of occupational employment)
Private sector		55	38
	Manufacturing and building	22	46
	Distribution	10	19
	Services	22	40
Public sector, of which		23	83
	Core public service	18	84
	Commercial bodies	5	82
Self-employed, of which		22	27
	Agriculture	10	12
	Other	12	39
	Total	100

Source: The Pensions Board, “Securing Retirement Income,” May 1998.

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Composition of People at Work Covered by Occupational and Personal Pensions

		Employment by category	Pension coverage
		(In percent of total employment)	(In percent of occupational employment)
Private sector		55	38
	Manufacturing and building	22	46
	Distribution	10	19
	Services	22	40
Public sector, of which		23	83
	Core public service	18	84
	Commercial bodies	5	82
Self-employed, of which		22	27
	Agriculture	10	12
	Other	12	39
	Total	100

Source: The Pensions Board, “Securing Retirement Income,” May 1998.

62. The coverage by occupational pensions is significantly higher in the public sector than in the rest of the economy, owing primarily to the mandatory nature of the public sector pension schemes. In general, the coverage is higher for full–time, permanent employees than for those working temporarily or part–time: about 60 percent of all permanent full–time employees are covered by occupational pensions; by contrast, only 10 percent of temporary, part–time, and seasonal employees are covered by occupational pensions. Coverage also differs with the firms’ size: the smallest firms (with fewer than 5 employees) have coverage rates of less than 10 percent, whereas in large companies (with more than 500 employees) the coverage rate is close to 80 percent. The coverage rate also varies significantly by income level, with almost 90 percent covered in the top two salary deciles, and only 3 percent in the lowest decile.

63. Eighty–one percent of the occupational schemes are defined benefit schemes and the rest are defined contribution schemes. The level of an occupational pension is determined by the target benefit, net of the social welfare pension, since most occupational schemes are integrated with the social welfare old–age pension scheme. There is no large discrepancy between the levels of public sector and private sector pensions, both of which provide a benefit of about three–fourths of final pensionable pay. However, unlike private sector schemes, where benefits are usually indexed to the increase in the cost of living, civil service pensions are indexed to wages.

64. Social welfare pensions are financed out of the pay–related social insurance (PRSI) contributions, government transfers to cover the full cost of means–tested benefits, and a budget transfer covering the deficit on contributory pensions. In 1996, total pension–related budgetary spending amounted to 2.8 percent of GNP, of which 57 percent was allocated for financing the social welfare pensions and the rest for financing public service pension benefits.

65. Box 1 outlines the arrangements for pay–related social insurance contributions. As indicated below, the effective PRSI contribution rates tended to fall in recent years, reflecting measures taken by the authorities to narrow the tax wedge, particularly with respect to the low–paid jobs, and to strengthen employees’ incentives for taking low–paid jobs.

Evolution of PRSI Contributions

Sources: Budget 1994, 1995, 1996, 1997, 1998.

^1/In percent of weekly earnings

^2/Does not include health contributions and employment and training levies.

^3/Irish pounds

Evolution of PRSI Contributions

		1994	1995	1996	1997	1998
Employer PRSI rates 1/
	Standard	12.2%	12.2%	12.0%	12.0%	12.0%
	Reduced	9.0%	9.0%	8.5%	8.5%	8.5%
Employee PRSI rate 1/ 2/		5.5%	5.5%	5.5%	4.5%	4.5%
Weekly employee PRSI allowance 3/
	Full rate	none	50	80	100	100
	Self–employed	none	10	20	20	20
	Modified rate	none	10	20	20	20
Earnings ceilings
	Employer	25,800	25,800	26,800	27,900	29,000
	Employee	20,900	21,500	22,300	23,200	24,200
	Self–employed	20,900	21,500	22,300	23,200	24,200

Sources: Budget 1994, 1995, 1996, 1997, 1998.

^1/In percent of weekly earnings

^2/Does not include health contributions and employment and training levies.

^3/Irish pounds

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Evolution of PRSI Contributions

		1994	1995	1996	1997	1998
Employer PRSI rates 1/
	Standard	12.2%	12.2%	12.0%	12.0%	12.0%
	Reduced	9.0%	9.0%	8.5%	8.5%	8.5%
Employee PRSI rate 1/ 2/		5.5%	5.5%	5.5%	4.5%	4.5%
Weekly employee PRSI allowance 3/
	Full rate	none	50	80	100	100
	Self–employed	none	10	20	20	20
	Modified rate	none	10	20	20	20
Earnings ceilings
	Employer	25,800	25,800	26,800	27,900	29,000
	Employee	20,900	21,500	22,300	23,200	24,200
	Self–employed	20,900	21,500	22,300	23,200	24,200

Sources: Budget 1994, 1995, 1996, 1997, 1998.

^1/In percent of weekly earnings

^2/Does not include health contributions and employment and training levies.

^3/Irish pounds

C. Recommendations of the Report of the Pension Board

66. Considering the social welfare pension as a major instrument for poverty alleviation, the Pension Board proposed to raise the level of social welfare pension benefits over the next 5–10 years to the subsistence minimum, estimated at IR£96 per week, or 34 percent of average industrial earnings in 1996 terms.³⁵

67. The Board also emphasized the importance of raising the rate of coverage of supplementary pensions, and proposed to set an ultimate goal of ensuring that some 70 percent of the total workforce over age 30 are covered by supplementary pension schemes. Moreover, it recommended the introduction of a new type of pension provision—the personal retirement savings account (PRSA)—designed primarily for those who previously did not have access to occupational pension schemes—small business employees, and part–time, temporary, and seasonal workers.

68. Social welfare pensions. The Pension Board considered two scenarios: the baseline, according to which pensions are indexed to prices; and an alternative, which envisaged an increase in the level of benefits to 34 percent of average industrial earnings, with indexation of pensions to wages thereafter. The baseline scenario may not be realistic, since it would imply that in 2056 the replacement ratio would drop to 9 percent of average earnings. The baseline scenario can be modified, assuming no change in the pension replacement rate and an indexation of benefits to wages. The difference in the cost of the modified and the baseline scenarios amounts to almost 5 percentage points of GNP by 2046; an increase in the level of pensions from 28.5 percent to 34 percent of average earnings would add approximately another 1 percentage point of GNP to pension costs in 2046. The tabulation below illustrates the approximate trajectory of the long–term net pension expenditures under different scenarios, assuming that the pension scheme contribution rates are unchanged.

Net Pension Expenditures Under Alternative Scenarios³⁶

(In percent of GNP)

Sources: staff estimates, based on Actuarial Review of Social Welfare Pensions and the Pension Board Report.

Net Pension Expenditures Under Alternative Scenarios³⁶

(In percent of GNP)

	1996	2006	2016	2026	2046
Baseline	1.6	0.7	0.7	0.8	0.8
Modified baseline	1.6	1.4	2.0	4.0	5.5
Alternative	1.6	2.6	3.2	5.0	6.8

Sources: staff estimates, based on Actuarial Review of Social Welfare Pensions and the Pension Board Report.

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Net Pension Expenditures Under Alternative Scenarios³⁶

(In percent of GNP)

	1996	2006	2016	2026	2046
Baseline	1.6	0.7	0.7	0.8	0.8
Modified baseline	1.6	1.4	2.0	4.0	5.5
Alternative	1.6	2.6	3.2	5.0	6.8

Sources: staff estimates, based on Actuarial Review of Social Welfare Pensions and the Pension Board Report.

69. The Report pointed out that if budgetary transfers to the Social Welfare Pension System were frozen at their present level of 5 percent of total contributions, contribution rates would need to rise in the long–run by 19 percent, if pension benefits were indexed to prices, or by 227 percent, if pension benefits were indexed to wages.

70. To avoid the need for large increases in contribution rates or in budgetary transfers to the social pension system, the Board recommended setting up a fond, to be financed by an annual budgetary transfer of ½–l percent of GNP in 1999–2011 (Figure 1). The fund would help minimize the additional burden on future generations of taxpayers from implementation of the Board’s proposals on raising pension benefits. Specifically, the Board estimated that assets accumulated in the fond by 2031 would be worth IR£30 billion (26 percent of GNP). The gradual depletion of these assets, including the income generated from their investment, would be sufficient to cap the Exchequer transfers at 3.8 percent of GNP in 2011–2046. However, increases in contribution rates might still become necessary once the fond is folly depleted.

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IRELAND: DEPENDENCY RATIOS AND LONG–TERM PENSION OUTLAYS

Citation: IMF Staff Country Reports 1998, 126; 10.5089/9781451818703.002.A004

Sources: The Pensions Board “Securing Retirement Income”.1/ Gap between outlays and income from contributions (assuming unchanged contribution rates). Pension benefits are assumed to be raised to 34 percent of average earnings over the next 5 years, and indexed to wages thereafter. See Box 3 for details.

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Box 2.

Summary of the Assumptions Underlying the Pension Board Estimates

Annual real GNP growth:
	1996–2006		5 percent
	2007–2016		3 percent
	2017–2056		2 percent
Projected life expectancy at birth:		Males	Females
	1996	73.1	78.7
	2026	77.1	83.2
	2056	77.6	83.7

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Annual real GNP growth:
	1996–2006		5 percent
	2007–2016		3 percent
	2017–2056		2 percent
Projected life expectancy at birth:		Males	Females
	1996	73.1	78.7
	2026	77.1	83.2
	2056	77.6	83.7

The participation rate is assumed to decline for the cohort of people between 15 and 24 years of age, owing to increased participation in full–time education, and for men over 50, as a result of a higher incidence of early retirement. The female participation rate is expected to rise, with particularly dramatic changes for women of 35–54 years of age. The unemployment rate is expected to decline to 6 percent by 2007, and to remain unchanged thereafter. Average earnings are assumed to increase by 2 percent annually in real terms. The dependency ratio is expected to increase from 21 percent in 1996 to 53.3 percent in 2056—the number of pensioners in 2056 is expected to be more than three times larger than in 1996.

71. The recommendations of the Pension Board did not receive unconditional support from the government. The government agreed to examine the proposal of raising the pension replacement rate to 34 percent in the context of the overall budgetary situation and economic climate. It also set up an interdepartmental group to discuss the issue of advance funding of pension liabilities. The government welcomed the proposal to expand the coverage of occupational pension schemes, and accepted the proposal to introduce personal retirement savings accounts (PRSAs).

72. Occupational pensions. An expansion of the coverage of occupational (supplementary) pension schemes is another avenue for poverty alleviation among the elderly. Moreover, the introduction of PRSAs would improve labor market flexibility and remove some of the obstacles to the expansion of occupational schemes. These obstacles include the high costs of running the schemes for small companies or self–employed individuals, investment and annuity risks, information gaps, and insufficient access to occupational pension plans. PRSAs should be designed as an investment account owned by individuals and managed by an approved PRSA provider. The introduction of PRSAs would broaden the base of funded pension schemes, as long as they were available to everyone, irrespective of employment status.

73. An expanded coverage by occupational pension schemes is likely to have a limited effect on poverty reduction for the low–income group. However, it could be instrumental in raising retirement income for those middle–income groups that currently do not have access to company–run occupational pension schemes.

D. Long–Term Financing of Public Service Pensions

74. The public service pension schemes are financed on a pay–as–you–go basis as part of the public service pay bill, with costs met from current budget revenues and, to a limited extent, employee contributions. No provisions are currently made to meet future pension liabilities.³⁷ In 1996, gross civil service pension costs amounted to IR£ 608 million, or 1.6 percent of GNP, of which 0.3 percent of GNP was paid in lump–sum payments and the rest in pension benefits.

75. The public service pension schemes cover all permanent employees. Spouses and children are covered by a separate compulsory contributory pension scheme.³⁸ The statutory retirement age is 65, but civil servants can retire with immediate payment of their pension at any time after age 60. The retirement age for some groups, such as prison officers, may be as low as 50 years of age, provided they have 30 years of continuous service.

76. The current financial arrangements for public sector pensions are likely to come under significant strain in 2020–2035. The accrued public service pension liabilities to date amount to more than one–third of GNP (IR£15 billion). In gross terms, public service pensions are projected to peak at 2.3 percent of GNP in 2025–2030, compared with about 1.6 percent of GDP at present and a projected 1.4 percent of GNP in 2005, and to stabilize at 1.8 percent of GNP after 2040. This increase in pension outlays is expected to arise mainly from the age profile of the civil service staff—the major cohort of public servants includes individuals currently in their thirties and forties, who would reach retirement age in the 2020s. In addition, the increased share of female public service employees is likely to extend the period of benefit payments, owing to the longer female life expectancy; and the overall life expectancy is projected to increase in the medium term.

77. The Commission came to the conclusion that it was not feasible to switch the public service pension system to a funded basis, as this would have required an annual transfer of IR£700 million (1.7 percent of GNP)—63 percent higher than the 1996 transfer. In order to cover pension costs on a pay–as–you–go basis, a civil servant of 20 years of age would have to contribute to the scheme for 45 years at a 15 percent rate.

78. The estimates of the Commission were based on macroeconomic assumptions similar to those of the Pension Board. In addition, the Commission assumed that public service pay would grow at an annual rate of 1.5 percent in real terms. The rate of return was assumed to be 4 percent. The report proposed to establish a fund for partial funding of future pension liabilities, which would supplement the pay–as–you–go system. However, the report did not explore this possibility in detail, with regard to the sources of financing, or the magnitude of the fund. Another recommendation was to switch accounting of pension costs from cash to an accrual basis, which would provide a clear idea of the accumulated costs of the public sector pension scheme.

E. Conclusion

79. The cost of pensions in Ireland is expected to grow markedly over the longer run. Currently Ireland’s pension costs are much lower than those in other OECD countries, owing primarily to its favorable demographic profile and comparatively low level of benefits. However, the demographic profile of the population is projected to change significantly after 2026. Maintaining the present comparatively low level of benefits may be difficult in the long run, given buoyant economic growth and considerably higher levels of pension benefits elsewhere in Europe. Moreover, past experience suggests that benefits are likely to be indexed to wages, even if they are not raised in relation to average earnings.

80. The burden of higher pension costs can be eased if measures are taken in advance. In the next few years contributions toward pensions would exceed the cost of contributory benefits, which may provoke demands to cut PRSI contribution rates. The expected surplus, however, should not lead to cuts in the PRSI contribution rates: their reduction in the short run would have to be more than offset in the long run, boosting labor costs. Alternatively, if the government decided not to raise contribution rates, the fiscal position would be adversely affected by the higher budgetary transfers needed to finance the pension system. The dilemma confronting the authorities could be eased through advance funding of future pension liabilities. The current strong fiscal position provides a good opportunity for the government to smooth the burden of pension costs over time. This could be achieved either through rapid repayment of outstanding debt, which would reduce debt service costs in the future and thus facilitate the absorption of increased pension outlays, or through the creation of a fund for financing future pension liabilities when their cost is high.