Four key points 1.A thought experiment - New Zealand Limited - - PowerPoint PPT Presentation

Why 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

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Point 1: A thought experiment

Let‟s think about New Zealand Ltd‟s balance sheet assets

New Zealand Ltd Welfare services NZ Super Fund State housing Trading

• perations

ACC fund NZ Post Education services Real estate

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A thought experiment ..... 2

New Zealand Limited‟s balance sheet (BEFU- estimate y/e 2009)

Assets

$99.5bn (financial) $119.6bn (other) Total $219.1bn

Liabilities

$15.2bn (financial) $69.2bn (debt) $39.1bn (other) Total $123.4bn

Net worth $95.7bn Part ACC Part ACC

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A thought experiment ..... 3

ACC‟s balance sheet (BEFU 2009 – Note 17)

ACC Assets

$13.14bn

(“net assets”)

ACC Liabilities

$23.96bn

(gross „liability‟)

“Net liability” $10.82 billion

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A ‘really scary’ thought experiment ..... 4

NZ Super‟s „balance sheet‟ – only current pensioners

NZS Assets

Nil

NZS Liabilities

$80bn

Net ‘liability’ $80 billion

This picture is of zero concern either today or tomorrow

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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?

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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?

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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

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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

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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.

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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
• ver time

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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

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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

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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

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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
• wners should pay for today‟s costs – not

yesterday‟s or tomorrow‟s

• Tomorrow‟s employers/employees/individuals

can pay for their own costs

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A thought:

“Price fixing – a sensible arrangement not to confuse customers with too much choice”

The Management Contradictionary