Posted: 04 May 2007
Pension proposals deliver poor value for savers, says expert
Proposals by the Pensions Board on a new national pension system have been criticised as offering poor value for contributors. According to Dr Shane Whelan, an actuary in the UCD School of Mathematical Sciences, the proposals for mandatory savings accounts would “for the same level of contributions, produce pensions 10% to 20% lower than simply upgrading the basic state pension.”
In a paper presented to the Economic and Social Research Institute on Thursday 3rd May, Dr Whelan argues that the figures produced in the National Pensions Review are misleading and not consistent with market values as they ignore the market price of risk. “Marginal savers are required to assume an inappropriate level of investment risk and it is naively assumed that such risk will have no consequences” says Dr Whelan.
Dr Whelan’s paper entitled Valuing Ireland’s Pension System challenges the assumptions underlying the costing of alternative systems presented in the Pensions Board reports. It claims that by ignoring investment risk and its consequences, the cost and value of pensions are materially understated.
“The two reports of the Pension Board take account of the expected increased pension as a result of risk-taking but completely ignore the possible consequences,” says Dr Whelan. “What if there is a fall of over 50% in the world equity market, as has occurred a two year period since 2000? What if the real return from equities is negative over a fifty year period, as it was in France and Germany over the first half of the 20th century? The unreliability of the return from risky assets is why the market offers such a high risk premium.”
From the perspective of value-for-money for contributors, Dr Whelan compares the proposed new system and a sustainable pay-as-you go system, very similar to our current system. He concludes that the sustainable pay-as-you go (PAYG) is superior, delivering pensions of the order of one-fifth higher for the same level of contribution due to lower administration costs. Accordingly, he proposes that Ireland’s current PAYG system be developed into a sustainable version that provides all mandated pensions which “avoids the pointless toil in developing another system to deliver lower pensions.”
Dr Whelan advocates a system which is reassuringly like our current system, with the exception that the state pension is explicitly linked to average wage increases and structured more as a financial contract than the ill-defined, politicised social contract it has been to date. He also emphasises that the challenge to remove political discretion from state pensions should not be underestimated, especially given the historic importance of state pensions in Irish politics.
He accepts that it is possible to make a step change to the level of the state pension immediately, if it is believed that the current level is unacceptably low for the more affluent Ireland. But, he continues to suggest that such a change might offer an opportune time to clarify how the system will be modified if life expectancies change in the future.
“The current rapid improvement in life expectancies at older ages demands that we put in place now contingency plans and specify, at least in principle, how we might determine retirement ages in the future” Dr Whelan concludes.