Economics 06/03/2010: Pensions Plan that confirms my worst fears

Per comments to my blog posts on pensions:

Article 4.2.3. of the National Pensions Framework states (emphasis is mine):

"The individual will be provided with a range of investment choices reflecting different levels of risk, accompanied by suitable, easily understood information about the level of that risk and the benefits expected. The range of funds will include very low risk options to provide members with a high level of security on their savings. The Government will not, however, provide any guarantees on investment returns."

This resolves the issue of asymmetric nature of returns: we will be compelled to invest, but Government is not compelled to guarantee.

At the same time, provision of very low risk option plans – traditionally fixed income only funds – does not disqualify these funds from purchasing Irish Government bonds, implying that the funds are not shielded from the Government ‘borrowing’ against our pension savings. This, coupled with direct State oversight over the approved funds (see next quote) means that it will be difficult to create functional Chinese walls between the State and our cash.

“The limited number and types of funds (which will be required to have life-styling built in) available under the scheme will be provided by the private sector through a competitive process run by the State.”

So rationing is the State objective, making the funds subject to potential State interference and influence.

“Members will have the option of choosing between these approved funds or providers, or else they will be enrolled in one of the low risk default options. Charges will be kept to a minimum as marketing expenses and investment advice are minimised."

How is this automatic enrollment into ‘one of the low risk default options’ be determined – who will select a specific provider option? The State? Some proportional competitive formula? Either way, someone else will decide what to do with the money some of us will be compelled to part with. It is, therefore, a tax, especially absent guarantee of a return.

The last sentence above is beyond any belief. This the State pushing on a retail client a major financial undertaking, while promising to keep advice to a minimum?!


Per my concern with contractual aspects of the plan, the entire NPF makes no mention of any contractual arrangements under the proposed plans. This means that either the authors of the document did not understand the importance of securing pension holders’ rights, or they omitted this consideration to exempt the state from committing to any sort of a scheme-related obligations. My questions regarding the legal validity of this ‘pension’ arrangement in the future are, therefore, correct and justified.

There are no references to any value-for-money frameworks within the document, which puts it in direct contrast to the green paper on pensions (the latter being full of cheerful promises of delivering this golden fruit of all public sector schemes).

There is no economic impact assessment, and there is no actuarial evaluation of the new plan, which means that the Government has promised not to guarantee returns which may or may not resolve the problem of the pensions funds shortfall in 2030-onward. If this still qualifies as a well thought-through proposal, I am off fly-fishing for the rest of my life.


Page 19 of the NPF states: “…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.”

This clearly states that the Government does not contractually guarantee the benefit for which it imposes a tax. I would love to 'seek to sustain' my tax contributions to the State at the current rates, but hey, I am actually obliged to do so. The opposite is not true for the state's duties to me. Again, asymmetry inherent in the rights and obligations of taxpayers vis-à-vis the State are re-affirmed here.

Even more insulting is the NPF statement concerning the State employees Defined Benefit pensions which reads (page 46): “However, only these core benefits granted plus revaluations to date would be guaranteed, and this would be underpinned by regulation.” So while not guaranteeing ordinary taxpayers anything at all, the State guarantees a large proportion of the Defined Benefit Rolls-Royce pensions to its own employees.


With respect of tax relief ‘reform’ NPF states (page 30) that “Another reason is that people are often unsure about the value of the incentives provided by the State to encourage pension provision. By providing a matching contribution equivalent to 33 per cent tax relief, the Government will introduce more transparency to the system – allowing people to see the exact value of the Exchequer support.”

This is pure hogwash – if people are unsure about the speed limit on the road being in miles or kilometers per hour, does the state change the number on the speed signs? And why not provide relief at 41%, or better yet – at 50%, since the Government is now taking half of the paycheck for many employees in this country?

With respect to opt-outs:

Section 2.3.2 page 17 states: “If people decide that retirement saving is not feasible, they can opt-out but there will be a once-off bonus payment for people who contribute to the scheme for more than five years without a break in contributions.”

In other words, the State will restrict competition in pensions provision by subsidizing the ‘approved’ plans mentioned earlier. In effect, to discourage people from undertaking purely private pension provision.

Page 32 states: “Employees will be permitted to opt out of the auto-enrolment scheme after a period of three months. Employees can opt in again whenever they wish but, in any event, they will be automatically re-enrolled every two years... Once a person remains in the scheme for six months, their contributions will be held in a pension account and no withdrawals will be allowed.”

So I am right to state that there can be instances of double payment into pensions funds by individuals who opt-out for a private pension. And that there has not been any thought given to how this can be avoided and how duplication of pensions will be prevented.

Page 34: “To ease administration costs, contributions will be collected through the PRSI system. In addition, the opting in/opting out arrangements will be made as straightforward as possible. The Government recognises, however, that any additional labour and administration costs will have an impact on small firms, particularly in the current economic environment.”

So it is a tax that will impact more smaller firms. And it will be the State who will collect the funds and then, somehow (how – remains to be determined) disburse these funds to ‘approved’ providers and to the ‘low risk option’. The latter, of course, being some new state quango managing the new retirement tax windfall. How will our choice of provider be entered into? How can we switch from one provider to another? How can we carry our pensions out of the state if we move places of work, including with the EU? Which open up another question – is this proposal actually in compliance with EU directives on portability of benefits?


There is an amusing table 4.1 on page 32 that illustrates just how dire is both the analytical part of the NPF is and how dangerous the Government promise to provide minimal advice can be. The table calculates replacements and returns on pension savings under the new scheme using an assumption of, hold your breath, 7% investment returns per annum! This, in the view of the report authors represents a safer type of investment…

I really rest my case here. Good luck to anyone who still believes this proposal to be a well thought-through idea.

Economics 05/03/2010: More questions on pensions plan

In a recent post (here) I have asked 12 questions concerning the new Government plan for pensions.

Here are more questions to follow. But before we begin, let me state the following:

• Lack of clarity on any of the questions raised by myself and other observers,
• The fact that these questions can be raised in the first instance; and
• Two independent confirmations of my questions validity from the industry sources

show that I am right in suggesting that the entire plan is badly thought through and most likely represents a new tax with no contractually verifiable benefits.

Question 13: Given that the Government will be forcing people of all ages to save 8% of their income per annum for pensions provision, the plan is not even sufficient to provide reasonable pension protection for the 22-year olds who will be enrolled into it. How will it help to defuse the demographic (aging-induced) time bomb the Government is facing?

The Government is hoping to start enrollment in 2014. It is facing pensions system meltdown around 2030-2035, which will cover by then retired generations born between before 1965. These generations by 2014 will be of age 49 or more, with 18 years or more left to go before a pension. This, in turn means that their pension provisions should be in excess of 20% of their income, assuming they are starting anew at 2014. Massively more than 8% the Government has in mind.

At the same time, the younger generations pension savers will be facing a dependency ratio of less than 2 workers per retiree by 2050. This means their total provision for pensions as well should be around 18-20% of their income annually. With 1/4 of this delivered in a promissory Government offer of 35% AE state pension, even assuming the Government will keep its promise, the unfunded contribution required is around 13.50-15% of income annually. Not 8% set by the Government.

Then there is a third sub-component of those who are in the older (pre-1970) cohorts who are currently outside private pensions schemes. They will require savings of more than 25% of their income annually to underwrite reasonable pensions provision. Again, 8% state run pension is not going to cover their shortfalls.

Question 14: If the funds were to go into the NPRF, then the life-span of the cash in the fund is about 5-10 years before the money is spend on some new emergency, e.g. another banks bust or another fiscal crisis (potentially the one induced by the collapse of the public sector pensions scheme). How will the Government protect our money from itself? It was not able to do so with the current NPRF set up and the signs are not good for any future funds security.

Question 15: Given that public sector pensions insolvency is already a known, the best for the Government to do is to reform the Rolls-Royce pensions it provides to its own employees. Why is the Government not leading by example?

Question 16: Anyone who has been outside the state scheme for 2 years will be automatically re-enrolled into the system. In the period of time between the re-enrollment and a new opt-out (which can be months), a taxpayer will be liable to pay into two pensions simultaneously (her own private plan and her state plan). Is this the case? How will the Government compensate such families who will incur overdraft charges due to such double pension provisioning courtesy of the state? How will the state actually monitor the opt-outs and whether people in the opt-out are still in a pension plan?

Question 17: What is the feasibility of the entire proposal ever being implemented, given the logistical nightmares it would entail?

• The proposal would require massive bureaucracy (and invasion of privacy) to verify - e.g. Revenue data being used by another State agency to generate demand for enrollments, re-enrollments and clear opt-outs. Is this even legal?
  
• The proposal will require the state to engage in the areas in which it has no expertise, running an investment undertaking with retail clients. What are the implications of a massive state monopoly with statutory enrollment powers to the market for pensions and financial services in Ireland? How long and how expensive will be the state battle with the EU Competition authorities to clear this scheme?
  
• How big will the paper trail be if the state were to require continued monitoring of compliance with the opt-outs? What will be the cost of this to businesses and employees? How many paper pushers will the state need to hire to keep the track of these mountains of evidence?
  

From the point of conception, to the point of translating the new authority's documents into Irish, the undertaking cannot be envisioned as an efficient and cost-competitive operator.


So why is the Government engaging in the scheme at all?

Since 'resolving the pensions problem' is clearly not on the cards (see above), one possible explanation is to get its hands on more cash through 'borrowing' against the funds raised. Another possible explanation - to raise tax (unimaginable otherwise) on business.

Remember -

• corporate tax is a sacred cow of the State;
• personal income tax is already high and will rise again in the next Budget;
• indirect taxes are crippling and the local authorities will be coming for more of their cut in the next few years.
  

So the only means for raising new cash is to levy a new charge - on businesses and incomes - that can be called something else other than tax. A promise of a service (new pension) 20-plus years down the road is a fig leaf of decorum, especially since the Government has no contractual obligation to actually honor such a promise and has set no specific target for a return on this undertaking.

This pensions proposal is a tax on employers (+2%) and a tax on people (+4%). And this tax will have the greatest negative impact on smaller businesses and entrepreneurs, since MNCs and larger companies are already offering much better pensions.

The Government might have solved the conundrum it faced courtesy of the EU Competition rules. Unable, since 2003, to charge differential tax rates on domestic and multinational businesses, it now devised a 'pensions' scheme to charge smaller companies more through a new levy. And it didn't have to raise official corporate tax rate to do so...


Of course, there is always a better solution than what our folks in the Government Buildings can deliver. That solution would be -

1. set a flat income tax rate of 12% on all income and no exemptions except for a generous up front personal tax-free limit (to exclude the real working poor from taxation);
   
2. And then tell people - including public sector workers - that they must invest at least 10% of their income in pensions of their choice, provided privately with real international competition in place (my preference would be to avoid compulsion, though);
3. Make the entire pension contribution, up to 20% of gross income, tax deductible;
   
4. Set up self-funded insurance scheme to underwrite pensions providers;
5. Done. End of story and no need for white papers from over-paid and over-staffed task forces and for bureaucrats, lawyers, mountains of paper and pensions tzars.
   

Simple, folks. Really simple. Chile did so already.

Economics 04/03/2010: Another grab of taxpayers cash?

Update 1: 04/03/2010: 10:15pm


Yesterday, the Government announced a plan to reform pensions provision system in Ireland by creating a mandatory pension scheme with a limited opt-out clause. The announcement is covered here. While lacking specific details we can only ask questions and await for some answers, here are my top-level views.

Question 1: Will additional contributions required from the taxpayers yield additional cover over the already committed state scheme that supplies 35% of the average earnings in exchange for PRSI contributions?

Question 2: What will determine the return on top-up pension? While the state is quick at setting the cost to the taxpayer (4%) and employers (2%) there is absolutely no reference to the returns to be earned from the scheme. Is the rate of return fixed? Guaranteed? Market-related? Who will underwrite this return?

Question 3: Who will manage the assets? NPRF? NTMA? Private providers? Who will actually write the policy - if any policy will be written at all.

Question 4: The plan exempts those on defined benefit pensions - aka public sector workers. Thus, in effect, the plan opens up two massive problems:

• Defined benefit pensions are the ones that are facing the largest shortfall and they are also being managed by the agent (the State) who will control our top-up pensions. How is this conflict of interest going to be resolved? Will public sector pensions hole be plugged using top-up pension funds?
• Defined benefit pensions are contractually guaranteed, while top-up pensions are not (see below), so in effect the opt-out potentially directly exposes ordinary taxpayers to underwriting the public sector pensions through both their statutory pension (already the risk we are bearing) and through the top up. If so, the top-up element of the proposal is nothing more than a tax on ordinary income earners that can be used to cover public pensions shortfalls.

Question 5: A 4% top-up requirement for 'higher earners' (undefined level of earnings) will create a further erosion of the wage premium for higher educated and higher skilled workers in this country (on top of already punitive levels of personal income taxation). How does this square off with the Government intentions to build a Smart Economy, if Smart workers require higher wage premium?

Question 6: What are the contractual rights of the taxpayers paying top up rates with respect to the pension benefits?

A private sector pension is governed by a clear contract. This contract is fully enforceable in the court of law. State pensions (with exception of those provided to public workers) are not. If you doubt this statement - check numerous legal cases where this has been deemed to be the case.

And look no further than the change in the statutory retirement age that the Government is planning to enact. In effect, forcing retirement age 2-3 years forward means that all of us who have paid PAYE are now entitled to 2-3 years less of the benefits. If this was done by your private pension provider, you would have a legal case against a unilateral change in the terms of the contract. But because it is done by the Government and we have no written legally binding contract with the Government relating to pensions provision, the State simply can cut our benefits, while still requiring us to keep our end of the deal - continuing to pay into the PAYE pot.

So the biggest issue of all is - will the new top-up requirement be legally binding for both sides of the deal or will it remain asymmetric (and therefore subject to the risk of arbitrary changes in the terms and conditions by the Government)?

Question 7: The new pension system would re-enroll people who quit every two years. This begs a question - will this 're-enrollment' be performed with crediting for years lapsed or not. If yes, then the risk of underpayment due to interruptions will be borne by the collective pool of funding. Which means that everyone paying into the system will be at a risk of bearing the cost of higher jobs exits and unemployment. If no, how will the recovery of underpayment take place? Simply requiring people who dropped out to repay the shortfall accumulated over two years of absence will not work, as it will impose huge burden on those with uncertain employment prospects.

Question 8: How will the system manage those in part-time employment, self-employment and those with hybrid income sources (multiple jobs, etc)?

Question 9: Since top-up clause requires private pension plan with employer contribution in excess of 4%, can the new plan be deemed anti-competitive? For example, if a self-employed person obtains no contribution from the employer, does the new pension mandate commit a person to a minimum contribution of 6%, thereby forcing them out of other private pension arrangements they might have, which may include single payment/lump sum contributions?

Question 10: If a person is forced to switch away from a smaller pension plan into the 'top up' Government plan, given that Government plan is not comparable in terms of risk of payout to a private plan, will this not in effect reduce the quality of pension that the employee will obtain? In other words, the Government scheme might result in a reduced quality of pensions for some savers.

Question 11: Will the new top-up arrangement cancel out PRSI contributions, or will it be on-top of the PRSI levies? If the former, who will fund the 35% promisory note of statutory state pensions? If the latter, this constitutes a massive increase in taxation burden in this economy.

Question 12: How will the Government reimburse those of us who might have higher pensions contributions by employers, but whose employers will now opt for a default position and drop their contribution to the effective minimum of 2%?

So far, the proposal is yielding more questions than answers. Which, of course, simply indicates that there is a good chance that the Government has not thought through the whole scheme and might be risking entering into another 'Policy-based evidence' scenario for which we, as a country, are so well known around the world.

On the net, however, given the nature of the top-up arrangement, unsecured contractual status of the proposal and the fact that the State decided to exempt its own employees from the obligation, the whole proposal looks like another tax by the Exchequer.