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The Super Fund: Panacea or Placebo

What is the impact that New Zealand’s aging population will have on the ability to pay New Zealand Superannuation.

Wednesday, June 20th 2001, 3:29PM

What's the bottom line? More needs to be done.
With an aging population the cost of funding retirement income in New Zealand is set to increase steeply over the next 50 years. Irrespective of the 'Super Fund', future taxpayers will bear a large part of this burden and there will be a massive and growing inter-generational transfer of wealth.

Higher economic growth and more labour force participation are the key means by which NZS will be sustainable in the future. In turn, these factors depend on individuals' incentives to invest and work in New Zealand.

While the proposed Super Fund is one idea on how to partly fund future NZS commitments, it brings with it significant risks and costs. Meanwhile, the real issues about promoting economic growth and employment are more related to the design of NZS, not the funding.

We offer some ideas for change in the future related to the design of NZS and the process.

Public retirement income and moral hazard
One of the most common goals amongst OECD countries is the provision of an adequate retirement income for its citizens. New Zealand is no exception and has chosen as its first tier of retirement income a publicly funded scheme.

However, the provision of a publicly funded retirement income comes with a twist. If the general public believes that government will provide them with a reasonable retirement income, then the individual incentive to invest smart for retirement is reduced. The trick for government then is to strike a balance between providing a retirement income for those in need, while maintaining incentives to invest and work as an individual.

In New Zealand, the first tier of retirement income provision is NZ Superannuation (NZS). This is a 'pay as you go' scheme funded from the current tax take. People are also urged through public education and a host of other policy efforts, to generate other forms of long-term savings. That is, to create a second-tier of retirement income.

In providing NZS, the government must try to balance:

  • A retirement income level which the genuinely needy can survive on, and interest groups will accept; while
  • Ensuring private saving and investment incentives remain strong.

But, if NZS is too generous then it will weaken an individual's investment incentive and the second-tier of retirement income will dwindle. In addition, it is unclear just what the capacity of NZ households' is to build a second tier of retirement income. Furthermore, with an aging population, the cost of NZS is set to rise significantly over the next few decades.

These factors highlight why it is the design of NZS that is crucial to ensuring an adequate level of retirement income for all NZ citizens in the future, rather than its funding.

The aging population
It is estimated for New Zealand that the proportion of the population aged 65 years and over is to increase from 12% now to 27% over the next 50 years. It is thus estimated that the annual cost of NZS will rise from 4% of GDP now to over 9% by 2050.

Such a large inter-generational transfer of wealth may prove unsustainable in both an economic and political sense. Future taxpayers may be unprepared to pay the required tax and vote with their feet. More likely, other forms of tax revenue will be sought, or the generosity of NZS will alter (i.e., be 'needs tested'). For example, in anticipation of these events, Family Trusts and other forms of asset protection are growing rapidly.

The proposed Super Fund: Panacea?
Given this projected rise in the cost of NZS, the Government has proposed the establishment of a new 'Super Fund' to part pre-finance it in years to come. Annual contributions of tax revenue will be paid into the fund starting this fiscal year.

However, at its peak, the fund will cover only 14% of the entire cost of NZ superannuation - if all goes well. The fund is thus best regarded as smoothing the 'pay-as-you-go' public retirement income system. Meanwhile, the burden of NZS will continue to grow in the absence of any design changes.

Placebo?
The Government's proposed 'tax smoothing' fund aims to create more certainty about the availability of future NZS. But, does it really do this and any more so than other alternative uses of tax revenue?

First, even with the introduction of the fund, the ability to pay for future NZS is still entirely dependent on the size of the tax base at the time. Meanwhile, the 'opportunity costs' of that taxpayers money goes unknown. Alternative uses of government revenue exist, such as reducing the tax rate or government debt, or increasing spending on education - all of which boost economic growth. These policy alternatives can be managed while still providing NZS to those in need.

Given that the 'super fund' concentrates on funding rather than design issues, it is unlikely that the proposal will boost economic growth or labour force participation by more than the alternatives.

Second, the proposed retirement income scheme will not raise the pool of savings in New Zealand. Instead, it is only likely to alter the form of saving. Government saving will remain the same, with no increase in revenue or reduction in expenditure committed to. In fact, the creation of the fund could dent people's willingness to save and invest smart as individuals, given the moral hazard discussed earlier.

Third, the Government is taking more financial risk onto their balance sheet (as opposed to paying down public debt) which implies no risk-adjusted gain on the use of tax revenues. Meanwhile, the fund will create costs in terms of parliamentary time and focus, publicity, management and salary costs, and other compliance costs.

Fourth, the incentive structure for the funds' managers appears weak. Even with the fund, future retirement income remains underwritten by the government's ability to raise tax revenue - not on the returns of the fund.

Fifth, it is difficult to see how or why the proposed fund could be modified to include individual accounts. The incentives for individuals to save and invest wisely would remain the same since:

  • The amount paid into the fund would remain the same (i.e., not actuarily assessed);
  • And, the retirement income paid out would be the same (i.e., not 'needs based').

Practical issues would also remain, such as who qualifies for an account, when can people get access to these funds, and what would happen if someone leaves the country or dies early?

Overall, we believe that while partly assisting the funding, the proposed 'Super Fund' appears costly and risky, and does not build on the relative competencies of the public and private sectors.

Moving forward - a partnership solution
Under the current level of generosity, the cost of completely pre-funding the future liability of NZS is already too great for the economy to manage. In order to meet the growing NZS payment either:

  • Economic growth must rise;
  • More people need to remain in the labour force;
  • NZS will need to become less generous; and/or
  • More saving will need to be made now to partly pre-fund the future costs.


In other words, we need to search for the combination of policies that best encourages wealth creation and labour force participation, while also providing an adequate retirement income to those in need.

The focus of public policy on superannuation over recent years has been on creating the necessary conditions to ensure that individuals save and invest. These efforts have revolved around: public education, ensuring a competitive funds management industry and an adequate range of savings products, improving the neutrality of the tax system, and building on the credibility of public policy. While there appears no reason to dilute or compromise this good work, there are strong reasons to supplement it.

For example, the key focus of the funds management industry has been on people in the upper end of the income scale or in some employer schemes. However, from a public policy perspective, it is the middle and low income New Zealanders whose retirement income provision needs attention. People in these income groups are well aware of the need for long-term savings, but are neither well informed about the options, nor able to afford it. Several policy options are possible, as discussed below.

The first tier of income
The NZS could persist as is. However, the generosity of the NZS would need to change as it becomes expensive with an aging population. This means immediate discussion is necessary on the design of NZS, rather than debating its funding. The issues include the state pension age, dollar amount paid, inflation linkage, generosity of the NZS compared to other forms of welfare, and qualifications for payment - including needs testing. For example, it is sensible that someone wealthy is being subsidised in retirement by someone earning a below average wage? Or, why are NZS payments more generous than welfare payments to someone who is disabled or unemployed? And so on.

If NZS changes prove equitable and efficient (they are necessary), then they should be confronted as early as possible. The current working population should be given every opportunity to prepare for their retirement, with adequate time, information and savings vehicles.

The 'Todd Taskforce' canvassed these issues in the 1990s and the 'Retirement Income Commission' appears more than capable of leading the debate in a bipartisan fashion.

A second tier?
If we are interested in design modifications to NZS then there are many variants more efficient than the Super Fund. For example, the government could provide a retirement-income subsidy for middle and low-income New Zealanders, which mimics the current employer-based schemes. For every dollar saved by an individual below a certain income level, the government could match it dollar-for dollar until a long-term savings level is reached that provides an annuity in retirement.

The savings would not be accessible until retirement age and the payment would be as an income stream, rather than a lump sum. Meanwhile, the current NZS could be left purely for those people not in the labour force for whatever reason.

In such a system, individual names are attached to the savings, and the private sector is competing to manage the funds and calculating the annuities actuarially correctly. Meanwhile, government support is better targeted, and moral hazard in terms of saving and investment decisions are minimised.

The overall retirement income system would also be more affordable, efficient, and arguably equitable. The public and private sectors are both using their relative expertise. The funds are privately managed and long-term savings goals are met accordingly. And, fund managers are left with very strong incentive structures to perform well as future retirement income levels will depend on them.

The system remains flexible for future changes to generosity of the scheme and there is no need to create an independent government structure. The system can be implemented using the current tax collection system. Also, those who do not earn any income for whatever reason will not be disadvantaged since the current NZS could still be available as a retirement income of last resort. Finally, the most important outcome is that incentives to save and invest smart remain strong and on the individual.

Of course, the devil is in the start up detail of such a scheme. But being tough to start is no excuse for not starting - especially in this $5 billion industry.

The bottom line
No matter what the NZS system, New Zealanders will need to rely on several levels of retirement income provision. By the time the current workers are all retired, these incomes may include:

  • Some form of 'needs tested' public retirement income;
  • Possibly a government supplemented individual retirement scheme; and
  • Various other forms of private savings.

Amongst this combination, the proposed Super Fund is not the make or break of retirement income provision.

Since it is future taxpayers that will face the growing NZS commitments, in order to make sustainable changes now a bipartisan political approach appears necessary. Otherwise, it will remain too easy for the current generation to vote for the most generous future offerings - the temptation to 'take the candy from the baby' will dominate.

Article from Westpac Trust - Quarterly Economic Overview

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AMP Home Loans 6.99 5.99 6.29 6.60
AMP Home Loans $200k+ 6.89 5.89 6.19 6.50
AMP Home Loans LVR <80% - - 5.85 6.29
ANZ ▲6.74 6.05 6.49 6.65
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ANZ Special - - 6.09 -
ASB Bank ▲6.75 6.09 6.40 6.65
ASB Bank Special - 5.95 - -
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BankDirect Special - 5.95 - -
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BNZ - GlobalPlus 6.49 5.99 6.39 6.59
BNZ - Mortgage One 6.90 - - -
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eMortgage 6.04 6.15 6.69 7.19
Finance Direct 6.10 6.45 6.69 7.10
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First Credit Union 6.45 - - -
General Finance 5.95 6.25 6.50 7.10
HBS Bank 6.15 5.85 6.20 6.25
HBS Special - - - 5.95
Heartland 6.45 6.75 7.00 7.60
Heretaunga Building Society 6.25 5.85 6.50 -
Housing NZ Corp 6.50 6.00 6.30 6.60
HSBC Premier 6.59 5.95 5.99 6.25
HSBC Premier LVR > 80% - - - -
HSBC Special - 5.85 5.85 5.85
Kiwibank 6.40 5.99 6.29 6.29
Lender Flt 1yr 2yr 3yr
Kiwibank - Capped 5.65 6.50 - -
Kiwibank - Offset 6.30 - - -
Kiwibank LVR > 80% - - 5.85 6.29
Liberty 5.64 - - -
Napier Building Society 5.80 6.00 6.70 -
Nelson Building Society ▲6.95 ▲6.15 6.60 -
NZ Home Loans 6.35 6.09 6.40 6.65
Perpetual Trust 7.70 - - -
RESIMAC - lo doc 7.34 7.06 7.38 7.82
RESIMAC LVR < 80% 6.34 6.06 6.38 6.82
RESIMAC LVR < 85% 7.34 7.06 7.38 7.82
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RESIMAC LVR < 90% 8.34 8.06 8.38 8.82
SBS Bank 6.15 5.85 6.20 6.25
SBS Bank Special - - - 5.95
Silver Fern 5.95 6.10 6.55 7.05
Sovereign ▲6.85 6.09 6.40 6.65
Sovereign Special - 5.95 - -
The Co-operative Bank 6.45 6.00 6.00 6.25
TSB Bank 6.49 6.00 6.19 6.60
TSB Special - - 5.80 -
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Westpac 6.24 6.09 6.39 6.65
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Westpac - Capped rates - 6.49 6.99 -
Westpac - Offset 6.24 - - -
Westpac Special - 5.95 - -
Median 6.45 6.00 6.39 6.60

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