Pensions Time-Bomb
Hibernian market research 2005:
· 69% still have no pension cover
· Rising to 75% for private sector workers
Pension Affordability
To fund a comfortable retirement at 60 (two-thirds of pre-retirement income) a 35 year old needs to be putting aside a minimum of 20% of their salary every month, and increasing contributions as they get older.
For example, at 60 a retirement fund of €100,000 buys an annual income of €5,340 but at 70 it buys €7,480. (Source: Hibernian)
However, most Irish people prioritise house-purchase over pension provision. The house-price inflation over recent decades means that funding both a mortgage and an adequate pension plan simultaneously is beyond the financial reach of most wage/salary earners. This becomes even more challenging if the cost of rearing and educating a family have also to be taken into account.
At the same time, the concept of “a job for life” in the private sector has become largely a thing of the past. In addition, those companies which do fund employee pension plans are moving to “defined contribution” plans rather than the traditional “defined benefit” plans.
This means that the retiring employee is exposed to the vagaries of the investment markets and the performance of the pension fund managers. But, more importantly, their pension benefits are no longer linked to their final salary but rather to their salary averaged over the term of their employment - typically from a relatively low starting point to a maximum at the finishing point.
Demographic Trends
- Number of people aged 65+ set to double over the next 25 years.
- Numbers in long-term care set to go from 84k in 2003 to 144k in 2031 and 203k in 2051.
2005 ESRI study (2063 sample size)
Over 80% felt it “very important” to be able to stay at home as long as possible.
Only 7% wanted to move to a nursing home or hospital.
a) 4% felt that individual should pay
b) 42% felt Government should provide full funding
c) 54% felt cost should be shared between individuals and Government*
* however, when the level of individual contribution was quantified for Option (c), this support fell off rapidly. At only €8 per week (€400 pa), this option was now rejected by two-thirds of those who originally chose (c).
60% of respondents were “definitely opposed” to older people re-mortgaging or signing up to equity-release schemes.
Estimated home-ownership among over-65s (incl. those with mortgage)
Ireland, USA, Australia = 80%
UK, France, Italy = 66%
Germany = 45%, Netherlands = 40%
Possible Solution
Irish people enjoy one of the highest levels of home ownership in the western world and it will remain the number one investment priority for most people.
It is an entirely logical and highly commendable aspiration - it provides security of domicile in old age and, as mortgages have generally been cleared by retirement age, the avoidance of rent provides a significant boost to the disposable income of such retirees.
Given that “the family home” will be the largest asset most of us will own outright, what is missing is a trusted mechanism to allow people the option to release the equity in their homes should they need it, while still enjoying the use of their home “in perpetuity”.
Proposed Mechanism
1. The Government introduces a scheme whereby it purchases the family home from the owners at market value.
2. The vendor is granted a “lifetime lease” at a rental cost linked to some published rate such as Euribor. (The potential rate may be capped to provide financial security to the tenant.)
3. The lessee (s) is clearly identified and the lease is strictly non-transferable.
4. The lease is terminated by (a) death of the lessee or (b) vacation of the premises by the lessee for a period exceeding 12(?) months.
5. Surviving heirs have “first refusal” on purchasing the property, using the same valuation mechanism originally employed at (1) above.
- Having the Government as Landlord should remove much of the concern felt by elderly people about long-term security of domicile which may attach to existing equity-release schemes.
- Item (5) above should re-assure vendors (and their heirs) about what constitutes “market value” and that unfair advantage is not being taken.
- It will also permit the home to stay in the family should that be the desire of the family.
Funding the Scheme
The primary capital funding of the scheme should come from the National Pensions Reserve Fund (currently valued at €15bn+). In essence it would be investing, on a commercial basis, in the Irish Residential Property Market.
When a sufficient stock of houses had been accumulated (e.g. 2,000 units with a cumulative value of €1bn) these could refinanced through a secondary mechanism.
Secondary Funding Options
A “Securitisation”-type approach
The freehold of the housing stock could be sold off in large blocks (e.g. minimum 100 properties or €40-50m value) to long-term investors e.g. banks, pensions funds, private investment consortia etc..
The terms of the sale would ensure that the landlord/tenant relationship between the Government and the original vendors (and their heirs) would be unchanged by this arrangement.
Unit-Linked Funds
In time, it should be possible to sell on the investment to the general public through the mechanism of Unit-linked Funds.
In the early years there would obviously be liquidity issues, as the turnover of purchased properties would initially be very low. It would probably take 15-20 years for a cash-flow equilibrium to be established - balancing between houses purchased and vacated houses sold.
However, in time this would cease to be an issue and, in any event, companies such as Irish Life have been selling highly-illiquid commercial property funds to the general public for decades - so valuation and encashment mechanisms clearly exist.
There are a number of possible knock-on benefits that may derive from this particular funding option:
Investment Buyers are provided with an alternative property vehicle. Such a vehicle should be attractive as it spreads the risk among a large number of properties.
The knock-on effect might be to reduce the level of “investment” activity in the New House/ Apartment market and take some of the heat out of price rises.
It would also allow “ordinary savers” to become investors in the property market without having to take on the burden of mortgages, managing properties etc..
First-time Buyers would be able to invest directly in the housing market, without seeing the buying power of their savings diminished as the rate of increase in house prices rapidly outstrips the interest earned on savings.
This might reduce their “panic buying” of properties in order to get on the property ladder.
Which, in turn, might also contribute to taking some of the heat of house-price inflation.
One aspect that needs to be considered is the gearing effect of a mortgage. It should be possible to provide either public or private finance to allow FTBs invest in housing through the Unit-linked mechanism, should this be desirable in the public interest (potential impact on house prices).
Main Barriers to success
1. Cultural attitudes to “owning one’s own home”.
2. Desire to leave the house to the family.
3. Attitude of potential inheritors.
4. Risk of family (or others) manipulating elderly parents in order to realise their inheritance early.
Possible Solutions?
1. A Government-guaranteed lifetime tenancy agreement in their own homes might convince many older people to cash in their equity in order to improve their quality of life. Clearly a role here for a sustained education and marketing campaign.
2. Vendors can always manage the cash received as frugally as they wish and/or can distribute it as they see fit. The "first refusal" option for heirs to repurchase the property should also help.
3. Potential inheritors will display a wide range of reactions, ranging from benign disinterest to naked greed. Other than pointing out to them that they too will, in time, be able to benefit from the exercise of the same option, it’s hard to see what reassurance can or should be offered to them.
4. Part of the overall process should be a step to ensure, as far as it is possible to do so, that the vendor is acting of his own free will and is capable of understanding the implications of the transaction.
The Potential Prizes
1. Dismantling the Pensions time-bomb for up to 80% of the population
2. Providing funding for quality long-term care for the elderly.
(The State should not be expected to pick up the financial burden of such care in circumstances where the elderly person is the owner of significant property assets. Such an approach should allow for better state funding of care for those who are not in a position to fund it themselves.)
3. Helping to achieve a “soft-landing” in the residential property market
4. Giving First-time buyers a chance to get on the property ladder without crippling themselves financially.
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