Cullen debunks super myths

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Finance minister Michael Cullen discusses "some of the more outrageous claims and myths that have grown up around the (NZ Superannuation) Bill."

Monday, August 20th 2001, 12:23PM

The New Zealand Superannuation Bill is two thirds of the way through its passage through the House and the debate is heating up.

Today I would like to take some time going through the Bill with you and talking through some of the more outrageous claims and myths that have grown up around the Bill over the past year. I can then answer any questions you may have at the end of the session.

My colleague Steve has handouts of this presentation and they will be made available for you.

It is a simple fact that New Zealand's population is ageing. Now 12 percent of us is aged 65 or over. Within the next 50 years, that ratio will have risen to 25 percent.

Not only will the proportion of retired people to workers increase but, as life expectancies continue to grow, the average period spent in retirement will also increase.

The cost of providing New Zealand Superannuation will make a much bigger claim on the public purse in the future than it does now. Now it commands about 4 percent of all activity in the economy. By 2050, it will command around 9 percent.

Basically there are only two ways to reduce this burden: either cut the pension or smooth the costs of it by putting money aside now.

National's intention is to cut the pension. You may not know that because they are not very honest about it. They don't shout it from the rooftops. Instead they talk very softly about how they will not cut entitlements for current retirees and say nothing about their longer-term plans.

They have a faultline running right through their policy which is why they need two spokespeople. Bill English talks for the future retired. Someone else altogether talks for the currently retired. They have two tongues on super' because they are two-tongued on super'.

The Labour Alliance Government starts from the premise that a society should be judged on how it treats both its youngest citizens and its old.

The entitlements contained in Part One of the New Zealand Superannuation Bill now before the House are, we believe, the minimum necessary to allow superannuitants an adequate standard of living and the opportunity to participate in their community.

National had reduced the wage floor from 65 percent to 60 percent of the average, after tax, ordinary time weekly wage. We have taken it back to 65 percent.

But it is important to remember that the 65 percent is calculated for the married rate. A single pensioner gets around 60 percent of that, or around 40 percent of the average wage.

You cannot cut that without forcing people into hardship and this Government will not do that, especially as almost half of this generation of retirees depend on the pension as their only source of income. And frankly, there is no reason to expect that ratio will change significantly in the next few years.

So Labour and the Alliance explicitly reject National's cost-cutting agenda.

The Government acted with integrity in, having committed ourselves to maintaining the pension at current entitlements; we then found a mechanism to pay for that commitment.

The proposed New Zealand Superannuation Fund does that. Our political opponents - and particularly Mr English - attack the plan constantly not because they think it will fail but because they are scared it will succeed. They simply cannot allow the Labour-Alliance coalition to pull off an achievement of that size.

The Treasury has done excellent work in designing the structure and governance arrangements for the Fund. These are incorporated in Part Two of the Bill and were recently described by a leading international expert in superannuation funds are "a world-class solution."

Let me now go through the Bill in some detail.

The New Zealand Superannuation Bill is in three parts:

• Part 1 covers existing NZS entitlements,
• Part 2 deals with arrangements for establishing the New Zealand Superannuation Fund and
• Part 3 covers the processes for political sign up to the legislation and making changes to the legislation.

No change to current entitlements

There will be no change to current New Zealand Superannuation entitlements. Existing legislation relating to NZS entitlements has been taken out of the Social Welfare Transitional Provisions Act and placed alongside the funding elements in the New Zealand Superannuation Bill.

This transfer has been used as an opportunity to correct some drafting in the old legislation. The wage-floor of NZS has been set in the legislation at 65% of the average wage.

The drafting of the Living Alone rate of NZS has also been clarified:

Superannuitants who are living alone receive a higher rate of payment than superannuitants who are married or are sharing accommodation. Originally this was provided in the form of a ‘living alone payment’ but this was subsequently incorporated into the Living Alone Rate

In previous drafting there were in effect two ‘entry points’ to receiving the living alone rate- the rate set out in the first schedule of the Act and the criteria for receiving the living alone payment.

In the Bill it is clear that the criteria for receiving the living alone rate are the appropriate entry point to the rate.

Part of the eligibility criteria for the Living Alone rate is that a pensioner must be resident in one of a number of specified types of accommodation. These accommodation types are listed in the legislation. In previous drafting it was unclear that the list is intended to be exclusive, and not a set of examples. This has also been clarified.

Key Elements of Fund Design

Part 2 of the Act establishes the New Zealand Superannuation Fund and sets out how it will be financed.

The key elements of the design of the fund are that:

• There is a transparent process for determining the contribution required for the fund
• The contribution to the fund will be based on a legislated formula with a long time horizon
• The board of the fund will have independence from government in determining its investment strategy and processes
• The board will be required to meet commercial investment objectives
• The fund will smooth the increase in the cost of New Zealand Superannuation over time

Transparent Annual Funding Process

The contribution to the fund will be assessed annually as part of the Budget process. And Treasury will calculate the rate that is required.

• The contribution is calculated by determining the costs over a forty year period and making an annual contribution into a New Zealand Superannuation Fund that would be sufficient to meet costs for 40 years, if it was applied in each of those 40 years.
• Contributions will be determined as a percentage of GDP.
• Each year, the rate will be recalculated and will exclude the past year and include the next year 40 years in the future. In this way it will be calculated on a 40 year rolling horizon.

Independent Governance

• There will be "double arm’s-length" between Minister and Fund.
• Prudent commercial management, and consistent with "avoiding prejudice to New Zealand’s reputation as a responsible member of the world community."
• Minister appoints from a shortlist prepared by a nominating committee.

Investment Objectives

The board will set its investment strategy in the context of the investment objectives set out in the Act. The Fund is to be managed on a prudent commercial basis.

While the board will set the investment strategy, it is anticipated that it will do so on the basis of best practice portfolio management.

The board must be mindful of risk in determining its investment strategy and any impacts its investments may have on New Zealand’s reputation as a responsible member of the world community.

The Fund is to be used to meet NZS payments only. It will not be used to meet other government objectives.

Smoothed Pay-As-You-Go Funding

We currently have what is called a "pay as you go" system, where NZS is paid out of the Government’s current tax receipts. The form of pre-funding we are considering is "smoothed pay as you go". This will involve creating an investment fund that will accumulate and invest funds. These funds will be drawn on to augment the "pay as you go" system to pay NZS as costs increase in the future.

Now, let me deal with some of the criticisms of the Fund and the myths that have arisen in recent months.

Opponents of the Fund raise two criticisms. They say the Fund will only ever supply around 14 percent of New Zealand Super costs. In fact the total share will be closer to 25 percent.

They are counting only the amount which will be directly drawn from the Fund. They are forgetting the further - substantial - revenue stream the Government will receive through the taxes paid on the Fund's earnings.

We have never claimed the Fund would fully meet Super costs and have always been careful for this reason to describe it as a partial pre-funding scheme. But a 25 percent contribution is a lot better than nothing. Without it, a future government would have to cut spending, raise taxes or opt for a combination of the two.

As to the larger debt issue, this Government's objective is to keep net debt below 20 percent of GDP and the budget has us achieving that with room to spare while we simultaneously put savings into the Fund.

The second criticism can be just as easily dismissed. Political opponents argue that, because the dollar level of government debt is rising, the government is borrowing to pay into the New Zealand Superannuation Fund. That is nonsense.

I have always said that the contributions to the Fund will come from the operating balance and the latest budget shows this is achievable. It has operating surpluses of $1.4 billion in fiscal 2002, and $2.4 billion, $3.1 billion and $3.7 billion in subsequent years.

These forecasts are fully adequate to, indeed they are 72 percent above on average, projected transfers into the Fund of $600 million in 2002, and $1.2 billion, $1.8 billion and $2.5 billion in the years following.

Let me finish with a little myth busting:

MYTH: The Fund will be monstrously large

The purpose of the Fund is to smooth out the cost of NZS to the rest of the Crown over time. The cost of NZS now is less than its expected cost in the future, so the Fund builds up and is drawn back down as the Crown adjusts to the higher ongoing cost of NZS later this century.

At its peak, the Fund is expected to grow to about 50% of New Zealand’s GDP. This expected level of the Fund is fairly robust.

If you lower assumptions about expected rate of return, a higher capital contribution is required so these even out in the expected Fund level. However, with decades of compounding actual returns, reasonably wide confidence intervals need to be placed around this expected level, perhaps in the range of 30% to 70% of GDP. There is not a target level for the Fund; its level is just a consequence of smoothing the cost over a forty-year rolling-horizon.

MYTH: It is better to pay off debt

This myth sees paying off Crown debt as an equivalent form of public saving that could be used to achieve the same ends of building a more robust Crown financial position to help cope with the increasing demands expected on the public purse later this century.

If the planned savings in the Fund were instead put to paying off debt, net debt would be down to zero before the end of this decade and so it is only a few years until the issue would need to be faced of how to best govern a growing pool of financial assets.

Debt is already down to comfortable levels. Paying down debt is no longer the fiscal imperative it has been in the past. Without a formal process to increase public saving, Budget demands will mean that net debt is unlikely to improve.

Finally, let's look at what's to stop future government's raiding the Fund.

The law will require governments to make sufficient annual contributions to the Fund to meet the annual costs of NZS for at least the next 20 years. The Fund will gradually build up during this time, and its size will be the best indicator of the security of future NZS. Any government that tried to raid the pensions of the next generation would suffer at the court of public opinion.

The experience of successful schemes overseas is that consensus developed, not before, but after the scheme was established. Again, as the fund built, people began to derive a sense of security from it and were anxious to see it protected and maintained.

I am confident that will also be the case in New Zealand and that - finally - we will have succeeded in putting superannuation above the political game.

This is the copy of a speech Finance Minister Michael Cullen made to Grey Power in Palmerston North.

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