Automatic Enrollment: Revisiting the Original Proposal Jim Stewart - PowerPoint PPT Presentation

Annual NERI Labour Market Conference Webinar 17-18 th September 2020 Automatic Enrollment: Revisiting the Original Proposal Jim Stewart Adjunct Associate Professor in Finance, School of Business, Trinity College, Trinity Business School, Trinity College

Some Features of Automatic Enrolment • The program for Government (May 2020) stated that a new Automatic Enrolment (AE) pensions scheme “will be introduced”. • An AE scheme was first discussed in a Green paper on pensions in 2007. • In 2010 a Framework document described in some detail a proposed AE scheme. • Employees without pension coverage and with earnings over €18000 (indicative) would be automatically enrolled in a pension scheme. • There were variations on the 2010 scheme announced in a Roadmap for pensions in 2018 and in October 2019. • Employee and employer contributions were each set at a maximum of 6% of earnings. With the State contribution to be decided . 2

Stated Reasons for Introducing AE • The Roadmap (2018) AE scheme is very similar to the original proposal. • But reasons for introducing an AE scheme are somewhat different. • Both proposals argue that pension savings are inadequate. • Both reports have a policy objective of increasing private sector pension saving. • Both reports state that concurrent with inadequate retirement savings the Social Insurance Fund/State pension funding will face increasing deficits. • Actuarial Reviews of the Social Insurance Fund have linked changing demographic structures to the viability of State old age pensions. • Forecast deficits have proved to be highly inaccurate. • The Actuarial review for 2010 had forecast a deficit of 3 billion. • The Acutarial review for 2015 forecast a €0 surplus • The actual position was a surplus of €1.4 billion for 2019 (although a large deficit is likely for 2020). 3

UK Data and Adequacy • The Framework document (2010) states that introducing an AE scheme would increase “coverage and adequacy”. • The Roadmap (2018) has references to increased coverage but no reference to increased adequacy from an AE scheme . • Evidence from the UK shows that following the introduction of AE, coverage increased, but contribution rates fell (Table 1). • Savings per eligible saver are low, indicating future problems with pension adequacy. • Average contribution to DB type schemes was almost five times high than DC schemes. 4

Table (1) :UK Data: Coverage versus adequacy 2012 2013 2014 2015 2016 2017 2018 Average contribution 9.7 9.1 4.7 4 4.2 3.4 5.0 to DC schemes (%) (6.6) (6.1) (2.9) (2.5) (3.2) (2.1) (2.4) Average contribution 20.1 20.6 20.9 21.2 22.7 25..2 25.6 to DB schemes% (16.2) (15.2) (5.2) (15.8) (16.9) (19.2) (19.2) Amount saved per £7000 £6957 £6653 £5774 £5418 £5387 £5110 ‘eligible saver” • Employer contributions are in brackets 5

Returns assuming 7% • Reasons given for an AE scheme are broadly similar in both reports. • But key assumptions underlying the proposed AE pension scheme have changed substantially. • For example (1), Table 2) shows the projected value of returns using Framework document assumptions. • Assumed returns are 7% per annum (net of costs); 40 years of contributions; an annual salary of €40,000 with a contribution rate of 8% of salary. • The value of the lump sum after 40 years is €698000, and assuming an annuity rate of 24 (4.1%), the yearly pension is €29,000. 6

Returns assuming 1% • Example Table (2) example (6) assumes that returns fall to 1% per annum and there is a 12% fall in the value of the accumulated fund at the end of every decade. • The value of the accumulated fund falls to €113,000 and the annual pension is €4,721 (assuming the same annuity rate). • The total value of all contributions (€127,680) is greater than the value of the pension fund assets. • However from an employees perspective, the accumulated lump sum is still greater than the sum of employee contributions (€63,840) because of the value of the employers contribution and tax reliefs. 7

Table (2): Returns using different assumptions Example 1 Example 2 Example 4 Example 5 Example 6 7% return 5.5% return Example 3 7% return, 4.5% return, 1% return, 12% fall 1% return 12% fall at 12% fall at end at end of every end of every of every decade decade decade Annual Salary 40,000 40,000 40,0000 40,000 40,0000 40,0000 Monthly salary €3333 €3333 €3333 €3333 €3333 3333 Total contribution €266 €266 €266 €266 €266 266 Value of Fund €113,315 €698,200 €463,116 €156,911 u€442,168 €240,493 Yearly pension €4,721 €29,091 €19,296 €6,538 €18,423 €10,020 Monthly pension 1 €393 €2424 €1608 € 544 €1535 €835 8

How realistic are returns of 1% ? • Chart (1) shows Euro zone 10 year government bond yields from 2014 to 2020. • The figure shows that average Eurozone bond yields have been under 1% since March 2019. • Irish 10 year bond yields have varied around 0% since August 2019. • German 10 bond yields have been negative since April 2019 and were -0.398% in August 2019. • These low and negative yields are likely to persist because of ECB policies to support the Eurozone bond market. 9

-0.5 0.5 1.5 2.5 3.5 -1 0 1 2 3 4 31/01/2014 31/03/2014 30/05/2014 31/07/2014 30/09/2014 28/11/2014 31/01/2015 31/03/2015 30/05/2015 Eurozone Bond yields 2014-2020 31/07/2015 Average for Eurozone countries 30/09/2015 30/11/2015 29/01/2015 31/03/2016 May 31 2015 July 29 2016 30/09/2020 30/11/2020 31/01/2020 31/03/2020 Irish bond yield 31/05/2020 31/07/2020 29/09/2020 01/11/2017 01/01/2018 01/03/2018 01/05/2018 German bond yield 01/07/2018 01/09/2018 01/11/2018 01/01/2019 01/03/2019 01/05/2019 01/07/2019 01/09/2019 Nov 29 2019 Jan 31 2020 March 31 2020 May 31 2020 July 31 2020 10

What about Volatility ? • Figure 2 shows the main Irish Stock market index for the last 25 years • Irish stock market indices have shown high volatility and hence risk, but Fig (2) this is also true of the Netherlands. • Fig (3) show similar volaltility for indices for UK and France. • Indices for many other countries show similar volatility. • These and many other indices are below their peak in 2000. • Volatility in stock markets indices is not necessarily indicative of volatility in pension fund assets. • However Stock market volatility is likely to be corelated with other asset prices, such as commodities and certain derivatives based on assets prices. 11

Stock Market Volatility ISEQ index compared with Netherlands index 1996-2020 12

Stock Market Volatility: UK index and French index 1996-2020 13

Conclusion • What is the most efficient system to deliver income to those in retirement , PAYG or a funded pension system? • A funded Automatic Enrolment (AE) pension scheme is not a solution for many of those without pension coverage because:- (a) Returns are low compared with initial projected returns of 7% per annum and are likely to remain low due to ECB policies and because of volatility risk is high; (b) For employees with low pay, variable work history with periods of unemployment, and frequent changes in employers, AE type schemes are unlikely to provide adequate supplementary pensions for those without pension coverage. (c) Costs for proposed AE scheme are likely to be large. For example costs due to, administration; the proposed Central Processing Authority; financial incentives, and managing funds. These latter costs will be capped at 0.5%,but this will exclude certain trading costs, for example in bid and ask spreads. 14