Tuesday, 6 April 2010

Is the National Pensions Framework a Policy for Pensions or a Policy for the Pensions Industry?

Gerry Hughes: In the National Pensions Framework document the Government points out that between 2004 and 2009 it increased the State Pension (Contributory) by almost two and a half times more than the increase in average industrial earnings and by nearly four times more than the increase in the Consumer Price Index. The increase in the real value of the State Pension resulted in a sharp fall in the risk of poverty for older people from 27 per cent to just over 11 per cent and in consistent poverty from 3.9 per cent to 1.4 per cent.

The strong effect on poverty rates of Government support for the public pension system contrasts with the weak effect on coverage rates of Government support for the private pension system by the introduction in 2003 of tax advantages for Personal Retirement Savings Accounts. Overall coverage of private pensions showed only a marginal increase from 52 per cent in Q1 2002 to 54 per cent in Q1 2008, according to the framework document. The National Pensions Policy Initiative target of 70 per cent coverage for those in employment aged 30 to 65, which was set in 1998, has not been attained. Coverage for this group increased from 59 per cent in Q1 2002 to only 61 per cent in Q1 2008.

The success of the policy of preventing poverty for older people by increasing the benefits of the public pension system is recognised in the framework document by a statement that “the Government will seek to sustain the value of the State Pension at 35 per cent of average weekly earnings and will support this through the PRSI contribution system. “ The Government also recognises that the PRSI system minimises administration costs, is relatively simple to understand and ensures security. However, instead of proposing to develop the public system to build on these strengths the Government simply asserts that the solution to Ireland’s pension problems is to introduce a new auto-enrolment, privately managed, supplementary pension scheme for all employees not covered by an appropriate occupational scheme. The contributions, amounting to 8 per cent for each employee (employee 4 per cent, employer 2 per cent, State 2 per cent), would be collected through the PRSI system and handed over in a competitive process to private pension providers.

No reason is given for why the pensions industry, and the Irish pensions industry in particular, should be rewarded in this way. In the financial crisis of 2008 Irish pension funds had the worst performance of national pension funds in 37 OECD and non-OECD countries. The Irish pension funds lost 37 per cent of the nominal value of their assets, or €27 billion, compared with an average loss of 20 per cent in the OECD area. Employees availing of the auto-enrolment scheme could be exposed to similar losses in the future because “the Government will not,…, provide any guarantees on investment returns.”

The framework document also proposes phased increases in the retirement age. Implementing these increases would reduce the expected lifetime value of the State Pension by 5.5 per cent for current workers aged 62 to 65, by 11 per cent for those aged 50 to 55 and by 16.5 per cent for those aged 49 or younger. At a time when people are reeling from shocks to the financial system, when many employers with DB schemes are reneging on their promise to provide a secure income in retirement and there has been a collapse in the value of pension assets in DC schemes, these are significant losses for the State to impose on employees who have fulfilled their part of the implicit intergenerational Pay As You Go contract on public pensions.
The intention of the proposed auto-enrolment scheme is to assist those in the lower to middle income range to make their own arrangements to bridge the gap and bring their post-retirement income up to the Government’s target of 50 per cent of pre-retirement income. The auto-enrolment scheme is unlikely to enable middle income employees to do this because the proposed contribution rate of 8 per cent is too low. An analysis in the Green Paper on Pensions shows that the average contributor to a PRSA is paying 10.5 per cent of salary and that this is not nearly enough to provide a replacement rate of 50 per cent of pay from a combination of a voluntary private and a mandatory flat-rate State pension.

The TCD Pension Policy Research Group has argued in Choosing Your Future, and Tasc has argued in Making Pensions Work for People, that there is an option available to the Government which would build on the success of the social insurance model in preventing pensioner poverty and provide replacement rates of 50 per cent of pre-retirement income for workers on middle incomes. This is the mandatory State earnings-related option analysed in the National Pensions Review published in 2005. It would provide a flat-rate pension of 34 per cent of average industrial earnings and a supplementary earnings-related payment that would provide an overall benefit close to the 50 per cent target for middle income workers. The total additional contribution required for this option would be 5 per cent to be paid by equal contributions by the employee and the employer of 2.5 per cent of earnings.

Regrettably, the framework document ignores most of the evidence in favour of the superiority of the social insurance system in delivering pensions and opts instead to reward the most incompetent private pensions industry in the OECD.


EWI said...

iIt's about time that this issue got an airing - kudos to TASC for doing so.

Mack said...

these are significant losses for the State to impose on employees who have fulfilled their part of the implicit intergenerational Pay As You Go contract on public pensions.

Gerry, the bolded text above is an oxy-moron. The unborn or young children are unable to enter into a contract - implicit or otherwise.

Passing pensions liabilities to the next generation works only so long as the number of workers continues to increase. Otherwise it's a Ponzi scheme.

Given increasing living expectancy and more importantly collapsing global total period fertility rates the dependency ratio is going only one way.

Who could blame our grand-children, if burden by unreasonable financial demands, they decide to repudiate an 'inter-generational contract' they did not enter into.

Proposition Joe said...


The really problematic case is where the inter-generational rug is pulled out after one cohort has fulfilled their side of the bargain but before they've reaped any benefit.

The coming "reform" will involve workers now in their late 40s, having paid their PRSI for the guts of three decades on the basis of this entitling them to the OAP at age 65, now having that benefit unilaterally reduced in value by a large margin.

Which is why a large body of people will understandably never trust the state with their retirement savings. Consider the spectacle of Mary Hanafin, who if she loses her seat in the next election will be in line to collect a massive ministerial pension, coming on the radio telling the rest us that unfortunately we'll have to wait til age 68 for a state pension worth less than 10% of the pension she may herself collect from age 52 or 53.

Diarmo said...

Another great post Gerry, thanks

Gerry Hughes said...

@ EWI & Diarmo: Thanks for your positive comments.

@ Proposition Joe: Thanks for highlighting what is at stake if the government proceeds to increase the retirement age for the State pension to 68 while allowing Ministers to draw their pension immediately if they fail to be re-elected.

@Mack: One of the lessons of the financial crisis which policy makers are ignoring is how risky the private pension system is. Pooling the pension risk in a PAYG system of social insurance is the most efficient and effective way to deliver a basic income in retirement.

Mack said...

One of the lessons of the financial crisis which policy makers are ignoring is how risky the private pension system is

Gerry, providing a future income at a given level involves risk no matter how it is achieved. Passing it onto future generations includes the risk that they will repudiate their 'responsibilities' either by cutting payments or raising retirement ages. In fairness the older / current power generation is already planning to make these types changes for my generation.

I've no problem with pooling risk per se, just with pooling risk with future generations where the dependency ratio is likely to much worse.

Joseph said...

@Mack - yes, the private pensions system is very risky - it was designed to be so that many levels of so-called professionals in the city/financial services industry could all make a nice living out of their cut of the punters' premiums.

All we are really seeing here though in the momentum behind the move from DB to DC schemes is the government/employers simply shifting all the risk and most of the cost onto the employees.

Until recently, I've spent over 25 years in the life and pensions business (thankfully left it now) and I've never met a marketing actuary yet who admitted to designing a product because it was good for the customer.

The pension timebomb so eagerly reported in the media and the need for people to provide for themselves is not much more than the usual neo-liberal scam. This is all about shifting the risk and the cost elsewhere - preferably on to the masses.

Mack said...


This is all about shifting the risk and the cost elsewhere - preferably on to the masses

And who do you think pays the taxes that fund pay-as-you-go systems? What happens when pensioners out number workers 5 to 1?

Mack said...

5 to 1 is probably too extreme (even allowing for unemployment, and including children) - I heard 3 to 1 somewhere and extrapolated.

Japan set for 1.5 potential workers per senior citizen by 2050.


At the moment 4 workers support 1 pensioners in Japan.

If all pensions were pay-as-you-go the cost is going to go by approx. 2.5 times for todays workers children.

Mack said...

In the Japanese case above - if the cost of paying pensions are passed onto children. The 1.5 workers per pensioner would be paying around 44.5% of salary to pay their parents pensions alone (assuming 2/3 final salary)! Never mind funding services or paying down that garguantuan Japanese national debt!