IIF Pensions Conference

1. IIF Pensions Conference Michael Culligan IIF Research Project 16 November 2006

2. Scope of IIF research • Life Strategies was commissioned by IIF to undertake two pieces of research • State pensions • Impact on Exchequer cost of gradually increasing the retirement age • Impact on Exchequer cost of providing a universal old age pension • Soft-mandatory system • Impact of introducing a soft mandatory system of supplementary pensions • But first, a quick reminder of the current system….

3. Reminder of current system • State pension • Flat rate benefit • Contributory (PRSI contributions) and non-contributory • Currently c. 33% of gross average industrial earnings (i.e. just over €10,000 p.a.) for single person • Recent increases have been well in excess of inflation • No explicit formula for future increases • Supplementary pensions • Either occupational or personal • Either defined contribution or defined benefit • Problems with current levels of coverage • Problems with future pension adequacy?

4. National Pensions Review • Conducted by Pensions Board in 2005 • Brought forward at request of Minister Brennan • Reconsidered targets set in 1998 NPPI Report • Adequacy: Pension of 50% of pre-retirement earnings (gross) • Coverage: 70% of workers aged over 30 • Examined alternative systems of pension provision • Some recommendations re matching contributions on PRSAs etc. (SSIA-style) • Note that coverage target is a means to an end (i.e. delivering adequacy) rather than an end in itself • Need 70% coverage because lowest 30% of earners will get a “NPR adequate” pension from State pension alone • Note that this implies 100% coverage amongst the remaining 70% - a challenging target!

5. Projected cost of current system • Table shows projected net Exchequer cost (as % GNP) • Note almost 3-fold increase in net costs • Primarily driven by increase in State & public service pensions • Assumes no increase in supplementary coverage from current levels

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

7. Projected life expectancy • Life expectancy is projected to increase • But always important to remember that no-one knows for sure • 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 • Used CSO methodology for longevity improvements • Based on extrapolating from recent experience • Equates to between Society of Actuaries “central” and “high” improvement scenarios

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

9. Agenda • Research into impact of changes to State Pension • Research into possible soft-mandatory system

10. Changes to State pension • Asked to provide alternative cost projections • (a) if State pension age gradually increased • (b) if universal pension paid (at level of contributory pension) • Increases in State pension age • These increases are in line with projected increases in life expectancy • Universal pension • Pay full pension to all (some terms & conditions may apply) • At the moment only about 42% of the male and 12% of the female over 65 population receive the full rate contributory pension

11. Changes to State pension • Results of projections • Projected cost of State pensions as % of GNP • Comments: • The increase in the retirement age has a considerable impact (almost 2% of GNP p.a. by the 2040s) • Paying a Universal Pension adds about 0.3% GNP p.a. to thepensions bill

12. Changes to State pension • Results of projections • Projected net Exchequer cost (as % of GNP) • Comments: • Increasing the State pension age dramatically reduces the overall increase in the net Exchequer cost • Even with universal pension, still cheaper than current system bymid-2020s

13. Agenda • Research into impact of changes to State Pension • Research into possible soft-mandatory system

14. IIF soft-mandatory system • Soft-mandatory system designed by IIF for us to examine • Supplementary soft-mandatory defined contribution • Every private sector worker (& self-employed) enrolled automatically • but can choose to opt out • Contributions levied on earnings above a lower limit of €16,000 and up to upper limit of €254,000 • Rationale is that State pension will provide adequate replacement rate for low earners & no need to replace income in retirement above an upper limit • Contributions from employer, employee and Exchequer • More detail on next slide • Pre-retirement access to funds • 25% of fund can be withdrawn tax free at age 25 • Subject to conditions, 25% of fund can be withdrawn tax free at age 35

15. IIF soft-mandatory system • Basic contribution rates • 5% from employee • 5% from employer • 5% from Exchequer (in lieu of tax relief) • 15% contribution in total • However, from age 25 onwards contributions may be increased to 10% from employee • If so, then Exchequer must match the increase • Employer still pays 5% • So, could be as high as 25% contribution in total • Contributions phased in over 5 years • Contributions only payable on earnings above €16,000

16. Projected benefits • Table shows projected pensions (replacement %) for various levels of starting salary, assuming minimum 15% contribution rate: • Comments: • Figures are for a 25-year old male, retiring at 65 with full contrib. history, and taking a CPI-linked annuity • These are “average” results – actual will depend on fund performance (DC) • Lower than NPR target replacement rate (50%) but not by much

17. Projected benefits • Table shows projected pensions (replacement %) for various levels of starting salary, assuming maximum 25% contribution rate: • Comments: • Higher assumed contributions deliver higher replacement rates • Allows for max. withdrawal taken at age 35 (25% of fund) • Replacement rates now higher than NPR target • Suggests that intermediate contribution rate would achieve NPR target

18. Macro perspective • Prepared “macro” projections incorporating the IIF’s proposed soft-mandatory system • For comparison against baseline of projections for current system • Same assumptions used as in earlier work for Pensions Board • National Pensions Review – examination of alternative systems (2005) • Special Savings for Retirement – examination of mandatory options (2006) • Assumed 80% take-up rate • Implies almost 65% of labour force would have supplementary pension • Also looked at 70% and 90% take-up • Looked at: • Projected total benefit payments • Projected total contributions • Projected net Exchequer cost • Possible economic impact

19. Projected benefits • Table shows projected benefits provided by IIF system compared to under the present system (as % of GNP) • Comments: • Projections are for supplementary pension system only • Projections for the current system show gradual increases in benefit payments as the supplementary system matures • Proposed system delivers additional benefits – pension payouts now 33% higher by 2040s

20. Projected contributions • Table shows projected contributions payable under IIF system compared to under the present system (as % of GNP) • Comments: • Projections are for supplementary pension system only • Total contributions under current system show an increase due to increased labour force participation, followed by a slight decrease caused by the trend away from DB to DC • Projections for proposed system show effect of additional soft-mandatory contributions (some replacement of existing provision is assumed)

21. Projected net Exchequer cost • Table shows projected net Exchequer cost of the proposed system compared to the current system (as % of GNP) • Comments: • Net Exchequer cost of current system set to increase almost 3-fold, as seen earlier • Proposed system projected to cost extra 0.3% of GNP p.a. but, if combined with changes to State pension, overall projected cost falls below current system

22. Possible economic impact • Not within the scope of our assignment but… • Can look to the work of the ESRI and Fitzpatrick Associates • Undertaken for the Pensions Board in 2005 and 2006 • Fitzpatrick Associates (2006) concluded that • Design of scheme will impact on likely economic impacts • Key design issues include • Coverage • Contribution levels • Cost distribution • Means of scheme introduction • Could have negative impact on labour market (with repercussions for competitiveness & economic growth) • But, with appropriate design and delivery could increase overall levels of saving and generate expansions in national output

23. Soft-mandatory – summary • Coverage • Should increase number with supplementary pensions • Should meet NPR target, but will depend on opt-out experience • Adequacy • In conjunction with State pension should deliver replacement income of c. 50% of pre-retirement income (NPR target) • Contributions & benefits • Overall projected to be somewhat higher than at present (assuming some substitution of existing voluntary provision) • Net Exchequer cost • Assuming no change in State pension age, the system is projected to cost an additional 0.3% of GNP p.a. • If State pension age increases, then overall net Exchequer cost is projected to be lower than for the current system

24. IIF Pensions Conference Michael Culligan IIF Research Project 16 November 2006