National Pensions Review - Assessment of alternative pensions systems

1
National Pensions Review - Assessment of
alternative pensions systems

• Presentation to Society of Actuaries in Ireland
• 18 January 2006
• Dermot Corry Michael Culligan

2
Agenda

• Summary of the assignment
• Methodology assumptions
• Results current system
• Results alternative systems
• Summary conclusions

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Summary of assignment

• Consultancy contract as part of National Pensions
  Review
• Jointly undertaken with ESRI
• Examination of a number of different pension
  systems
• Existing system (as baseline for comparison
  purposes)
• 5 alternative systems chosen by Pensions Board
  for investigation
• Quantitative assessment required
• Financial projection of each system
• To provide information re relative merits and
  sustainability of alternative systems
• Further assessment also required
• Economic impacts equity etc.
• Scope of assessment covers entire pension system
• Pillar 1 Pillar 2 Public service private
  sector

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Systems chosen by Pensions Board (1)

• Alternative 1
• Similar to existing system
• Tax credit at top rate (42) for all employee
  contributions,but cap on contributions eligible
  for tax relief
• Alternative 2
• Mandatory Pillar 2 DC (run by private sector)
• 5 employer plus 5 employee contributions on
  earnings above employee PRSI threshold to max. of
  twice GAIE
• Further voluntary contributions allowed
• Tax relief on contributions as for Alternative 1
• Alternative 3
• As for Alternative 2, but with mandatory DC run
  by State

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Systems chosen by Pensions Board (2)

• Alternative 4
• Mandatory earnings-related State-run system
• 1 of revalued earnings (above employee PRSI
  threshold to max. of twice GAIE) for each year of
  contribution
• Further voluntary contributions allowed
• Tax relief on contributions as for Alternative 1
• Alternative 5
• Enhanced Pillar 1 (50 of GAIE)
• Voluntary Pillar 2 as at present, but with tax
  relief capped as per Alternative 1

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Agenda

• Summary of the assignment
• Methodology assumptions
• Results current system
• Results alternative systems
• Summary conclusions

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Methodology assumptions

• Demographic and economic projections are the
  foundation
• Demographic projections based on CSO work
• Economic projections undertaken by ESRI (GNP,
  labour force etc.)
• Also need assumptions for each component of
  current pension system
• Pillar 1 beneficiaries entitlements
• Pillar 2 membership, contributions, assets,
  pensioners etc.
• National Pension Reserve Fund
• And, for each alternative system, need to make
  assumptions about impact, changed behaviour etc.
• e.g. what happens to current Pillar 2
  arrangements if mandatory system is introduced

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Demographic projections

• Projections based on published CSO projections
• CSO published figures to 2036
• We extended the projection period to 2056 (on
  same basis as CSO)
• Three scenarios
• Central scenario
• Higher immigration
• Extra increase in longevity from 2036
• Next slides summarise some of the key points
• Population size structure
• Life expectancy in retirement

N.B. Results on alternative scenarios not
included in this presentation
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Projected population (central scenario)
Big increase in over-65 pop.
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Projected life expectancy

• Life expectancy is projected to increase
• Table shows projected life expectancies for 65
  year olds
• In summary, life expectancies for 65 year olds
  are projected to increase by roughly 6 years by
  2056
• CSO methodology re longevity improvements
• Based on extrapolating from recent experience
• Equates to between SAIs central and high
  improvement scenarios

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Projected population age structure
61
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Economic projections

• Projections of GNP
• Allowing for employment growth and productivity
  growth
• Assumed rates taken from ESRI's Medium Term
  Review 2003
• Real wage growth is assumed equal to productivity
  growth
• Projections of size of labour force
• Assumed a gradual increase in female
  participation rates in the 35-54 age group
  (converging on EU-15 average by 2015)
• Otherwise, all participation rates as at present

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Other assumptions current system

• Retirement age of 65
• Pillar 1 benefits start at 34 of GAIE and are
  linked to earnings (rather than prices)
• Increasing of over-65s qualify for full COAP
  over time
• 80 of men and 57 of women by 2056 (Source
  DSFA)
• No. of public service employees remains at
  current level
• Assume Pillar 2 private sector coverage remains
  at current level
• PRSI contributions continue at current rates
• Count 85 of total PRSI contributions as
  pension-related
• NPRF drawdowns peak at 3.5 of GNP in late 2050s
• Fund is projected to be exhausted by c. 2070

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Agenda

• Summary of the assignment
• Methodology assumptions
• Results current system
• Results alternative systems
• Summary conclusions

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Results current system (1)

• Table shows projected net Exchequer cost (as
  GNP)
• Note almost 3-fold increase in net costs
• Primarily driven by increase in Pillar 1 public
  service pensions

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Agenda

• Summary of the assignment
• Methodology assumptions
• Results current system
• Results alternative systems
• Summary conclusions

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Results Alternative 1

• Recap Alternative 1 is a variant of the current
  system
• Tax credits at 42 for all
• Cap on eligible contributions (age-related and
  254,000 limit)
• Changes to base assumptions
• Assume increases in Pillar 2 coverage in lower
  income bands
• Results are very similar to current system
• Slight increase in net Exchequer cost (c. 0.2 of
  GNP p.a.)
• Due to assumed higher Pillar 2 participation
• Improvements in coverage/adequacy likely to be
  gradual
• To what extent will tax changes increase coverage?

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Results Alternatives 2/3

• Recap Alternatives 2/3 involve a mandatory DC
  scheme
• 5 employer 5 employee mandatory contributions
• Applies to earnings between c. 0.5 and 2.0 times
  GAIE
• Changes to base assumptions
• Assume no new entrants to existing voluntary
  Pillar 2, except highest earners
• Assume that voluntary Pillar 2 contributions
  reduce to take account of mandatory contributions
• Assume that public servants are covered by
  mandatory system

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Results Alternatives 2/3 (contd.)

• Projected net Exchequer costs
• Projections indicate a somewhat higher net
  Exchequer cost
• Cost of paying mandatory employer contributions
  for public servants
• Cost of tax reliefs on mandatory contributions
• Additional cost falls a little over time

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Results Alternatives 2/3 (contd.)

• What about adequacy of mandatory pensions?
• Table shows projected replacement rates for
  Alternative 2
• Comments
• Rates comprise Pillar 1 and mandatory pensions
• Rates are for a 25-year old entrant, retiring at
  65 with full contribs.
• Rates based on pension which is CPI-linked
• These are average rates actual will depend on
  fund performance
• Rates will be lower for older workers (shorter
  contribution periods)

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Results Alternatives 2/3 (contd.)

• Comments on Alternatives 2/3
• Acceptability of a mandatory system (esp.
  Alternative 2 which involves the private sector)?
• Good coverage but questions re adequacy of
  pensions which system will deliver
• Need for a State underpin to guarantee a certain
  minimum return on contributions?
• Some design advantages with DC flexibility re
  retirement age also easier to adjust for
  increasing longevity
• Exchequer cost somewhat higher (assumes public
  servants are included)
• Economic impacts relatively limited

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Results Alternative 4

• Recap Alternative 4 involves a State-run DB
  scheme
• Mandatory earnings-related system
• 1 of revalued earnings (above employee PRSI
  threshold to max. of twice GAIE) for each year of
  contribution
• Changes to base assumptions
• As for Alternatives 2/3, assume reductions in
  voluntary Pillar 2 entrants contributions and
  assume public servants are covered
• Firstly, we calculated the contribution rate for
  this system
• Calculated as 26.5 of pensionable earnings,
  assuming GNP growth
• Would be c. 20 if calculated allowing for real
  return on assets in excess of GNP growth, but
  questions about how achievable this would be
  given fund size

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Results Alternative 4 (contd.)

• Projected net Exchequer costs
• Projections are on funded basis
• PAYG would show positive cashflow for quite some
  time
• Projections indicate a somewhat higher net
  Exchequer cost
• Cost of paying mandatory employer contributions
  for public servants
• Cost of tax reliefs on mandatory contributions
• Additional cost falls a little over time (as
  voluntary Pillar 2 system declines and higher tax
  revenues flow from mandatory pensions)

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Results Alternative 4 (contd.)

• What about adequacy of mandatory pensions?
• Table shows projected replacement rates for
  Alternative 4
• Comments
• These rates are much better than for Alternative
  2/3 (almost double)
• But note that they are based on a pension which
  is earnings-linked, which should increase the gap
  even further over time
• Rates are for a 25-year old entrant, retiring at
  65 with full contribs.
• Rates will be lower for older workers (shorter
  contribution periods)

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Results Alternative 4 (contd.)

• Comments on Alternative 4
• Delivers NPPI targets (both coverage and
  adequacy)
• But is very expensive (contribution rate of 26.5
  on relevant earnings)
• Total pension contributions would double from
  their current level
• Substantial economic impacts
• Choice between Alternative 4 and Alternatives 2/3
  is analogous to ongoing Pillar 2 DB/DC debate

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Results Alternative 5

• Recap Alternative 5 involves an increase in the
  Pillar 1 pension (to 50 of GAIE)
• Immediate increase (i.e. all existing pensioners
  benefit)
• Voluntary Pillar 2 will continue as at present,
  but with caps on tax relief
• Changes to base assumptions
• As for Alternatives 2 to 4, assume reductions in
  voluntary Pillar 2 entrants contributions
• Assumed that the additional Pillar 1 pension
  (i.e. the extra amount resulting from the
  increase from 34 to 50) would be taxed at 20
• Firstly, we calculated the contribution rate for
  this system
• Calculated as 9.2 payable on all earnings

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Results Alternative 5 (contd.)

• Projected net Exchequer costs
• Projections are on funded basis
• PAYG would show positive cashflow for quite some
  time
• Projections indicate a higher net Exchequer cost
• Extra cost of immediate increase to existing
  workers/pensioners not met by extra contributions
  hence extra cost (but declines over time)
• Results are also affected by projected decline in
  Pillar 2 participation

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Results Alternative 5 (contd.)

• Comments on Alternative 5
• Simple, easily understood, easily administered
• Guarantees 50 replacement ratio for everyone
  earning up to GAIE
• Only system to have a beneficial impact on
  current retirees
• But, substantial and immediate increase to Pillar
  1 requires substantial additional contributions
  (9.2 on all earnings), with consequent economic
  impacts
• And also introduces additional liabilities which
  are not covered by the additional contributions
• Increasing Pillar 1 also exacerbates the
  sustainability questions which apply to the
  current system (if PAYG)

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Comparison contributions
Contributions to voluntary mandatory systems
as of lab. force earnings
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Comparison Age 30 coverage
Private public sector voluntary mandatory
arrangements (except for Alt. 5)
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Comparison Exchequer cost
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Agenda

• Summary of the assignment
• Methodology assumptions
• Results current system
• Results alternative systems
• Summary conclusions

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Summary conclusions (1)

• Ageing population will lead to substantial
  increases in Pillar 1 pension outgo
• But PRSI receipts are projected to remain stable
• Public service pensions will also increase at a
  similar rate
• Cost of current voluntary Pillar 2 system
  relatively stable
• (assuming no major changes in coverage)
• Overall, net Exchequer cost of current system
  will increase sharply
• NPRF will help to an extent, but will not solve
  problem
• Higher net immigration would also help
• But again, will not solve problem completely

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Summary conclusions (2)

• Results for Alternative 1 are very similar
• As we have assumed that the tax changes will not
  have a major impact on coverage
• Alternatives 2/3 achieve good coverage levels
  (70)
• But adequacy issues remain (lt50 replacement
  rate)
• Additional Exchequer cost economic impacts are
  not huge
• But DC nature of system may be unacceptable
  State underpin required?
• Alternative 4 is the closest fit to NPPI targets
• Good coverage good adequacy
• But at a price (doubling of existing
  contributions) and hence with significant
  economic implications

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Summary conclusions (3)

• Alternative 5 delivers reasonable adequacy
• And is the only one which benefits current
  retirees
• But exacerbates the sustainability issues with
  the current system (if PAYG)
• Note that total contributions of 9.2 of earnings
  are required to cover the cost of the increase in
  the COAP for new entrants
• But this still leaves an extra cost to be met
  over the coming decades in respect of the cost of
  the increased pensions paid to existing workers
  and pensioners

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National Pensions Review - Assessment of
alternative pensions systems

• Presentation to Society of Actuaries in Ireland
• 18 January 2006
• Dermot Corry Michael Culligan