AGEING POPULATION- Burden or Benefit?

20-22 January 2002

Balmoral Hotel, Edinburgh

DEFUSING THE DEMOGRAPHIC TIMEBOMB

Eamonn Heffernan

President of Society of Actuaries in Ireland

BACKGROUND TO THE ESTABLISHMENT OF THENATIONAL PENSIONS RESERVE FUND IN IRELAND

National Pensions Reserve Fund July 1999 - Government initiative announced Dec. 2000 - Legislation passed Contributions - €4.6bn (initial) + 1% p.a. of GNP

(to 2055) Objective - Meet part of Exchequer’s PAYG

commitments from 2025 (Social Welfare + Public Service Pens)

Funding issue addressed in 2 major reports“Securing Retirement Income” (May 1998)

“Commission on Public Service Pensions Report” (November 2000)

Economic Background

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1985-90 1990-95 1995-00 2000-05 2005-10 2010-15

Average Annual Growth Rates in GNP

Source: ESRI Medium Term Review 2001-2007

Population & Labour Force Projections

Source: Actuarial Review of Social Welfare Pensions

Ratio of those in elderly dependency ages to working age (20 to 64)

Number of working age per 100 persons aged 65 and over

1996 2006 2016 2026 2036 2046 2056

Elderly dependencyratio (%) 20.6 19.7 24.8 32.6 40.1 49.2 53.3

Number of working age per 100 persons aged 65 and over 485 508 403 307 249 203 188

Irish Social Security System

Virtually full labour force covered by Social Insurance Pension on retirement at age 65 (also invalidity plus

dependant’s pension) Benefits not pay related nor means tested Old Age/Retirement Pension (2002)

€147 p.w. (single)

€261 p.w. (where adult dependant)

33% / 58% of avg. earnings

Indexation of Social Welfare Pensions No stated Government policy 20 year history of increases

% p.a. % p.a. Increase relative toIncrease Prices Earnings

5 year periods

1982 – 87 6.5% 0.3% -4.3%

1987 – 92 3.9% 0.7% -0.5%

1992 – 97 3.2% 1.3% -0.2%

1997 – 02 8.3% 5.1% +3.5%

20 year period

1982 – 02 5.4% 1.8% -0.4%

Projected Cost of Irish Social Welfare Pensions

Total Outgoings as % of GNPYear Rates indexed Rates indexed

to Prices to Earnings

2001 4.4 4.42006 3.8 4.12011 3.6 4.32016 3.6 4.72026 3.6 5.72036 3.5 6.82046 3.3 7.82056 2.8 7.9

Securing Retirement Income

Report of Pensions Board to Government Part of National Pensions Policy Initiative (NPPI) Aim

“To have ……… national pensions system which enables all residents to acquire an income ……. to maintain established standard of living ….… retirement …….. incapacity ………… death of income provider”

Objective of NPPI“To facilitate national debate on how to achieve this aim

….. and to formulate a strategy and make recommendations for actions needed”

Report’s Conclusions on Coverage/Adequacy 2 Main Pillars

Social Welfare System Vol. Supplementary Pensions

Current Supp. Pens. Coverage (1995 Survey) 52% Employed 27% Self Employed 46% Total

Adequacy 50% of Gross Pre Retirement Income Min. of 34% of Avg. Earnings

Supplem. Pens. Coverage 70% of Total Workforce over 30

Report’s Conclusions on Indexation of Social Welfare Pensions If indexed to prices

“Pensions fall 28.5% to 9% of avg. earnings (mid century)” If indexed to earnings

“Outgoings increase 4.5% to 7.9% of GNP (same period)” Didn’t recommend automatic indexation to earnings Desirable to aim to increase pensions in line with

earnings Identified issues of intergenerational fairness and risk Sought to identify mechanism to alleviate these issues

Mechanism for addressing intergenerational issues Accumulation of Fund to smooth burden over

generations Purpose to place ceiling on Exchequer contribution Advantages

Spreading of cost Additional resources available Manage intergenerational transfers Better understanding of long term commitments Greater degree of trust

Mechanism for addressing intergenerational issues

Other Features No Irish Government Bonds

Managed by agency independent of Government

Clarity of acounting and accountability

No mixing of financial / social objectives

Comparison of Exchequer Cost of Earnings Indexation - with funding and PAYG (% of GNP, 1998-2046)

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98 01 06 11 16 21 26 31 36 41 46

With Funding Pay-As-You-Go

Public Service Pensions

Defined Benefit / Final Salary

Accrual Rate 80ths (Pens.) 3/80ths (Grat)

Minimum retirement age 60 - some exceptions

Spouses’ pensions + death gratuity

EEs contribute 6.5%

Pensions indexed to pay

Financed - PAYG

Projected Cost of Public Service Pensions as Percentage of GNP

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

1997 2002 2007 2012 2017 2022 2027 2032 2037 2042 2047

Benefit Outgo as % of GNP Member Contributions as % of GNP

Commission’s Recommendations in relation to Funding No need to fully fund in line with private sector Would do nothing to address “peak” Would, however, bring greater transparency Saw definite advantages in partial funding

Avert destabilising shifts in Govt. spending patterns Ensure diversification of expenditure during economic “boom” Ensure greater transparency/discipline

Considered reserve/private sector type funds Favoured latter Recommended funding of pension increases

Commission’s Recommendations in relation to Funding

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

1997 2002 2007 2012 2017 2022 2027 2032 2037 2042 2047

Benefit Outgo as % of GNP new pay-as-you-go plus fund contributions

National Pensions Reserve Fund

Key Provisions of Legislation Statutory obligation to pay 1% p.a. of GNP to 2055 Managed by independent commission with

discretionary authority Commercial investment mandate But no Irish Government Bonds Prohibition on drawdowns prior to 2025 Power to appoint investment managers/custodians Accountability to Minister for Finance / Parliament

And Now

Investment strategy 40% Eurozone Equities 40% Non Eurozone Equities (50% hedged) 20% Eurozone Bonds (2/3 passive, 1/3 active, no

Irish)

13/14 Specialist mandates (both active/passive) 580 applications from 200 institutions Market entry strategy devised Managers appointed shortly Fund approx. €8bn / projected €125bn (2025)

In Summary “The proportion of persons of working age to those over 65 years of age

is projected to fall from a current 5:1 ratio to less than 2:1 by mid century”

“Our projections indicate that the Exchequer costs will rise from 4.7% of GNP to 12.4% of GNP by mid century”

“The consequence will be either that taxes will have to rise dramatically to meet incrreased pension costs or else the value of pensions in real terms will have to be reduced”

“Fortunately because of our predominately young population and the economic boom, we have both the time and the capacity to prepare for the burden”

“The establishment of the Fund will go some way towards easing the burden for the next generation”