W hy pre-fund the ACC? Michael Littlewood Co-director, Retirement Policy and Research Centre University of Auckland Business School
Four key points 1.A thought experiment - New Zealand Limited 2.Borrowing to invest - a risky business? 3. Do we need actuaries to calculate the ACC‟s premiums? 4.Benefits unrelated to pre-funding 2
Point 1: A thought experiment Let‟s think about New Zealand Ltd‟s balance sheet assets New Zealand Ltd Welfare Trading Education services operations services NZ Super State ACC fund NZ Post Real estate Fund housing 3
A thought experiment ..... 2 New Zealand Limited‟s balance sheet (BEFU- estimate y/e 2009) Assets Liabilities $99.5bn $15.2bn Part (financial) (financial) ACC $119.6bn $69.2bn (other) (debt) Part $39.1bn Total $219.1bn (other) ACC Net worth Total $123.4bn $95.7bn 4
A thought experiment ..... 3 ACC‟s balance sheet (BEFU 2009 – Note 17) ACC ACC Assets Liabilities $23.96bn $13.14bn “Net liability” (gross „liability‟) (“net assets”) $10.82 bill ion 5
A ‘really scary’ thought experiment ..... 4 NZ Super‟s „balance sheet‟ – only current pensioners NZS NZS Liabilities Assets $80bn Net ‘liability’ Nil $80 billion This picture is of zero concern either today or tomorrow 6
A thought experiment ..... 5 • Pre-funding essential for private providers • Two main reasons: 1. Security of contractual „entitlements‟: • A provider may disappear • But the government will never disappear 2. Paying for the liabilities that accrue today • Intergenerational equity for private policy holders • Owners and markets need to know profits • Owners need a return on investment • But the government has the power to tax • So, why pre-fund? 7
A thought experiment .... 6 • The logic also applies to New Zealand Superannuation and the NZSF • If pre-funding were a good idea, what about: – Future health spending? – Future spending on education, defence, police? – Or anything else? 8
Point 2: A risky enterprise • Borrowing to invest leverages outcomes – positively and negatively • Borrowing to invest either smoothes „lumpy‟ commitments or is speculation • Borrowing in the presence of invested assets is the same economically as borrowing to invest The choice: - Borrow and maintain invested assets – that includes all financial assets - Not borrow and draw down on invested assets 9
A risky enterprise .... 2 - the government’s role • A government should clearly identify its role • Can it add value to the portfolio investing function? • Question not confined to the ACC fund • Portfolio investing should be left to private sector 10
A risky enterprise .... 3 - the investment hurdle • Cost of government‟s marginal long -term debt • Currently about 6% p.a. gross (2017 maturity - tax not an issue) • Fund must achieve 6% per annum, guaranteed • Hurdle rate changes with cost of debt • ACC fund‟s gross returns over: – Last year to 30.6.08: -0.8% – Last three years: 7.9% p.a. 11
Point 3: Do we need actuaries to calculate premiums? • The actuary‟s basic job - working out next year‟s premiums • Based on a mixture of: – Experience: actual claims, assets, investment returns, people data, accident rates etc. – Assumptions („guesses‟) : future experience of existing claims, new claims, future premiums, investment returns, interest rates • NPV „future liabilities less future income‟ • Compare with assets • Adjust difference through premiums now or over time 12
Do we need actuaries? …. 2 • Role of actuarial calculations for insurers: a) Ensure „ solvency ‟ now or over a period b) Monitor equity between groups of employers/employees/policy holders c) Assess provider‟s profitability for owners/markets • Solvency arguably irrelevant to ACC • User pays‟ arguably more relevant than equity for ACC • Profitability irrelevant to ACC 13
Do we need actuaries? …. 3 • Alternative approach based on PAYG principles • Can be occupation/employer/pay/motor vehicle specific (as now) • Add up the expected payouts in 2010/11 • Strike a 2010 premium that is expected to recover those • For more certainty, use a 3-5 year smoothing • 2010 premiums will be somewhat less • >$10 billion of assets no longer needed 14
Do we need actuaries? …. 4 • Advantages of PAYG – Removes uncertainty of investment returns – Avoids worry about actuarial „guesses‟ that must „work‟ over very long periods – Simple to administer and monitor – Easier to understand – Lowers political risk • Everything else similar to ACC is PAYG; why not ACC? • If ACC partially privatised, premiums on that business must be calculated as now (still no need for a fund) • The actuary can then retire 15
Point 4: None of this need affect benefits • We have only discussed how to pay for the ACC … • … not what the ACC should pay for • We should discuss what the ACC does but not because of shifting to PAYG • Today‟s employers/employees/individuals/car owners should pay for today‟s costs – not yesterday‟s or tomorrow‟s • Tomorrow‟s employers/employees/individuals can pay for their own costs 16
A thought: “Price fixing – a sensible arrangement not to confuse customers with too much choice” The Management Contradictionary
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