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National Pensions Review - Assessment of alternative pensions systems

National Pensions Review - Assessment of alternative pensions systems. Presentation to Society of Actuaries in Ireland 18 January 2006 Dermot Corry & Michael Culligan. Agenda. Summary of the assignment Methodology & assumptions Results – current system Results – alternative systems

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National Pensions Review - Assessment of alternative pensions systems

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  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

  3. 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

  4. 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

  5. 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

  6. Agenda • Summary of the assignment • Methodology & assumptions • Results – current system • Results – alternative systems • Summary & conclusions

  7. 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

  8. 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

  9. Projected population (central scenario) Big increase in over-65 pop.

  10. 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 SAI’s “central” and “high” improvement scenarios

  11. Projected population age structure 6:1 2:1

  12. 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

  13. 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

  14. Agenda • Summary of the assignment • Methodology & assumptions • Results – current system • Results – alternative systems • Summary & conclusions

  15. 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

  16. Agenda • Summary of the assignment • Methodology & assumptions • Results – current system • Results – alternative systems • Summary & conclusions

  17. 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?

  18. 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

  19. 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

  20. 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)

  21. 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

  22. 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

  23. 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)

  24. 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)

  25. 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

  26. 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

  27. 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

  28. 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)

  29. Comparison – contributions* * Contributions to voluntary & mandatory systems as % of lab. force earnings

  30. Comparison – Age 30+ coverage* * Private & public sector voluntary & mandatory arrangements (except for Alt. 5)

  31. Comparison – Exchequer cost

  32. Agenda • Summary of the assignment • Methodology & assumptions • Results – current system • Results – alternative systems • Summary & conclusions

  33. 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

  34. 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 (<50% 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

  35. 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

  36. National Pensions Review - Assessment of alternative pensions systems Presentation to Society of Actuaries in Ireland 18 January 2006 Dermot Corry & Michael Culligan

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