Pay as you go vs pre-funding
January 12th, 2010 at 6:00 am by David FarrarMichael Littlewood argues in this paper that neither ACC nor Superannuation should be pre-funded.
He argues that pre-funding of ACC should not just be delayed until 2019 (instead of 2014), but is inappropriate for a Government entity.
I suggest people read the full paper, bus his points in summary are:
- The ultimate owner of the provider, the government, will never disappear. Also, the government has the power to tax to meet future liabilities, expected or unexpected. The ACC has therefore no apparent need to maintain a pool of invested assets to pre-fund its expected, contingent future obligations.
- By maintaining the ACC Fund the government is effectively in the business of portfolio investing.. That is because, when the accounts for the ACC are consolidated as shown in Chart 1, the ACC’s investments become the government’s. The ACC does not itself
need to address the issue (whether or not to be a portfolio investor) but the government should. - Borrowing to buy portfolio investments (shares, bonds etc) is speculation – again, not necessarily a bad thing in itself. The borrower takes on the risk that the returns from those investments will be at least as great as the cost of the debt used to acquire them.
Borrowing to invest magnifies the yields and the losses. It turns a good return into an excellent return; and a bad return into a potential disaster.
Interestingly both Labour and National support pre-funding of ACC.
Tags: ACC, Michael Littlewood, pre-funding
January 11th, 2010 at 4:49 pm
“By maintaining the ACC Fund the government is effectively in the business of portfolio investing”
Anyone who’s familiar with Warren Buffet knows that every insurance company has money invested. Insurance by definition takes money which may not be needed for years, so that money has to go somewhere productive in the meantime.
Vote:January 12th, 2010 at 3:46 am
For me the main argument against “pay as you go” is that this approach is lacking in intergeneration equity. Should not the large cohorts that comprise the baby boomer generation not make more of a contribution to these services when they can best afford to particularly when the generations coming up behind them are not nearly as numerous.
Approaches that lack in intergeneration equity just result in the youngsters who would have otherwise paid the taxes buggering off overseas and increase the load on those left behind.
Food for thought perhaps ?
Vote:January 12th, 2010 at 8:54 am
Pay as you go has been advocated by the ILO. Prefunding appeals to those in waiting for privatisation. There are similar arguments about state contributory super where interest on members accounts can be a greater drain on the budget than simply paying a benefit. National Super is efficient that way. There is serious work showing future dependency ratios are invariant and that some of the populist bogies don’t really exist.
Vote:January 12th, 2010 at 9:15 am
I’m sure motorcyclists with large bikes will support this idea? But I thought the current crisis was caused by the investments that ACC already had crumbled to dust as a result of the world’s current problems? How do we know that the present money being put in the piggybank will not also dissappear? The gamble is to time things so the money is spent just prior to depressions, which are cyclical anyway?
Vote:January 12th, 2010 at 9:45 am
As David Farrar has suggested, you really need to see the paper where the arguments are all laid out.
Here in brief are some key points in connection with the above comments:
1. In very broad terms, the ACC last year collected about $4 billion and paid about $3 billion, even allowing for the improvements in benefits made by the last government. So, if a pure PAYG system had operated last year, levies could have been about 25% less, on average, than they were. So, the increases announced this year would have been unnecessary – levies could have been cut instead.
2. As the paper explains, the reason private insurance companies have money invested is because they might go broke and disappear. So they need to give surety for their contractual commitments. The same does not apply to the ACC which is a wholly-owned subsidiary of the government (AKA ‘all us taxpayers’).
3. The ACC Fund’s managers have actually done a fair enough sort of a job over the years so the levies are not rising mainly on that account; though there is an element (because over the years, the Fund has unsurprisingly missed the actuarial assumption about investment returns). The question is whether the government needs to have a fund at all. I argue that it does not.
4. The main reason for the supposed ‘hole’ in the ACC’s accounts is the changes to the actuarial assumptions. As these are really not much more than educated guesses, we don’t know whether they will be right over the coming decades. We wouldn’t even need to worry about that if the PAYG model were adopted. We wouldn’t need the actuaries.
5. Intergenerational equity is a red herring on this issue. Each year’s taxpayers effectively decide how to spend each year’s income (including ACC levies). Intergenerational equity introduces, unnecessarily in the government’s case, private insurance principles into what is really a social insurance scheme. If future generations of taxpayers can’t afford what this generation has promised itself, the promises will be reduced. We should not be concerned about that – it’s the way everything has always worked.
We really need a national debate on this issue.
Vote:January 12th, 2010 at 10:25 am
Unlike Labour and National, the Greens support returning the scheme to Pay As You Go, but maintaining a significant reserve, which it has already acquired over the years of moving to pre-funding, to smooth the possibility of major future fluctuations in levies. The rationale for this approach is perhaps best expressed by economist Susan St John in this paper:
Vote:January 12th, 2010 at 10:46 am
The key in this summary seems to be the distinction between ACC being based on a private insurance model, or being a social insurance scheme. Woodward recently stated his belief that ACC was a ‘welfare’ scheme not an ‘insurance’ scheme.
If ACC were to be a welfare scheme, and Littlewood’s arguments for PAYG are persuasive, then surely in time the coverage will be absorbed into the social security system (health, welfare etc.), rather than being separate. Forces are already at work endeavouring to widen coverage of the scheme (and both Woodhouse and Palmer wanted cover for illness) because of perceived inequities. Remember when Social Security was paid for by a separate levy of one and sixpence in the pound of income and then the levy was absorbed into general taxes; this will also likely happen in a PAYG ACC scheme.
Perhaps it is time to acknowlege that the ACC scheme is fatally flawed. If there were no ACC there would be fewer accidents, and people who cause accidents would be called to account. We have a free health system to help people recover from injury, that there are disability benefits. In cases of criminal negligence there should be a right to sue; the removal of this right is inequitable. And ACC is becoming a lot more expensive and wasteful than was anticipated when the no-fault concept was born.
Vote:January 12th, 2010 at 1:32 pm
Trout, who decides what is criminal negligence ?
Vote:Is ACC more expensive than the worker’s compo scheme in force in Australia ?
National telling the punters we are only dumping ACC for your good not to look after our mates in the insurance industry, the best of luck of trying to sell that one.
January 12th, 2010 at 1:58 pm
In relation to ACC I take your point Michael, intergenerational equity is a red herring. In the context of superannuation it is most definitely relevant. The beneficiaries of superannuation are not the same generation that pay for it and that surely is indisputable.
Vote:January 13th, 2010 at 12:09 am
One of the advantages of pre-funding ACC, and of the Cullen fund, was that they removed money from the economy when it was running hot, despite a strong desire on the part of the Government of the day to commit future governments to their spending structures. With the economy not looking so flash, both the Cullen fund and ACC prefunding could be reconsidered as a source of liquidity. And the Government has already made its decision on the near term future for the Cullen fund commitments.
Vote:January 13th, 2010 at 5:40 am
Again, picking up on some of the comments:
a. If the reason for having the ACC Fund and the NZ Superannuation Fund is to “remove money from the economy when it was running hot” then we should amalgamate the two funds and call the single fund “Knock The Top Off The Froth Fund”. That way, we wouldn’t need to pretend it was anything to do with ‘saving for retirement’ or ‘pre-funding ACC’. I still wouldn’t support the KTTOTF.
b. Intergenerational equity is a red herring for the superannuation discussion as well. Governments should focus on growing the economy rather than gaming financial markets. At the bottom of each page of any discussion about the sustainability of New Zealand Superannuation should be a line saying “How does this proposal help grow the New Zealand economy in preference to other ideas”. Superannuation (public or private; defined benefit or defined contribution; pension or lump sum – whatever) is a claim on tomorrow’s economy and it is only a healthier economy tomorrow that will support the growing (relatively and absolututely) retired population.
c. Trout suggests that, without ACC, we would have fewer accidents. I will be interested to see the evidence for that.
d. I agree that there is a discontinuity between aspects of our system that cover accidents and sickness. For me, I guess the key distinction is that, in accepting the principles of ACC, I am giving up my right to sue someone who does damage to me in an accident. If the ACC were to be merged as Trout suggests, I would want to have the right to sue restored. Having run legal claims under the pre-ACC system, I think that would be a retrograde step. I do not think the ACC is fatally flawed only that its finances can be more efficiently managed at a lower overall cost and with reduced risks than now. I do not argue for the ACC’s abolition; nor its merger with other welfare arrangements. Incidentally, the name is “Woodhouse” not “Woodward”.
d. The reference to the old Social Security tax is not really relevant as that didn’t pretend to cover the costs of Social Security even when it was first implemented in 1938. However I concede that if the ACC went fully PAYG, the ACC levy would be more clearly a tagged tax than pretending to be an insurance premium.
e. I am of course familiar with Susan St John’s paper (we are both Co-directors of the Retirement Policy and Research Centre). She argues for a more modest version of the ACC Fund than now so does not favour full actuarial pre-funding but, again, you need to read her paper that analyses the full history of the toings and froings on this issue over the 35 years since ACC started.
Vote:January 14th, 2010 at 2:59 pm
If a ‘state’ scheme is done on a ‘pay as you go’ basis, then the future liability incurred still needs to be assessed and factored into Government accounts. To do otherwise is effectively burying one’s head in the sand as to future liabilities. The World Bank, Moodys, etc would surely expect this when assessing matters concerning a nation’s sovereign debt. If someone asks Treasury what the Government’s off balance sheet liabilities and Treasury says it hasn’t a clue, who would want to lent the Government money. The risk of the Government having to plead forgiveness down the track becomes significant making it expedient for the prospective lender to tell the Government to go to Cash Convertors instead.
Even in the days of ‘defined benefit’ Government super the scheme available to public servants, local government employees, teachers, etc), I thought that the future liabilities should have been ‘marked’ by for example ring fencing a collection of power stations, public buildings, etc as super fund assets.
Vote:January 14th, 2010 at 3:24 pm
Peterwn
There is no real significance in ring-fencing assets; nor in even knowing what the NPV of the government’s expected financial obligations are. As I explained in the paper (that you need to read), there is no economic difference between ACC and New Zealand Superannuation. Moodys has no idea what the NPV of NZ Super payments are for the currently retired (in the paper, I have guessed about $80 billion) never mind the NPV of the pension for those who are yet to reach age 65 (probably another $80 billion or so). And it doesn’t matter that Moodys (or us) don’t know.
The same arguments apply to the DBP, unemployment benefit, the future cost of defence, law and order or anything else the government does. In all cases, taxpayers of the day decide what tomorrow’s governments will support.
The government will never have to go cap in hand to creditors with respect to the ACC or NZS – it will simply reduce benefits, increase taxes or a combination. That’s the way it has always been. It will only have to compromise with creditors if it keeps borrowing money to such a level that it can’t support the interest payments, let alone capital repayments. The NZ government is a country mile from anything approaching that status.
Vote:January 14th, 2010 at 4:55 pm
Surely Michael Littlewood’s last comments show the risk of arguing only from the provider or suppliers point of view. In his ‘gummint can’t go broke over ACC or NZS’ scenario the poor consumer/ taxpayer/ voter/ beneficiary simply gets lumped with more costs and reduced compensation, no real voting power to change the detail and doesn’t have an out.
Real lives can suffer real bad outcomes with pay outs based on govt fiscal health eg Bill Birch’s canning of lump sum compensations, leaving disabled lives on a trickle. Quite apart from everyone else living with a vague sense of generally declining value.
I’m open to alternative views than simple ‘public vs private’ provision argument but public provision seems always to run into medium/ long term decline in cost-benefit value and subject to naive or sectarian political pressures. I’m not yet satisfied with leaving the argument where ‘social insurance’ provision is sacrosanct vs ‘private insurance’ provision.
Vote:January 14th, 2010 at 8:01 pm
Bruceh
Why don’t we focus on just the ACC versus NZ Super case. Given that the ACC is a wholly owned subsidiary of the Government (that’s a synonym for ‘all us taxpayers’) what is it about the ACC levy raising/benefit delivery that distinguishes it from the tax raising/NZS benefit delivery.
As far as I can see there is no material difference so, if you are content to have a PAYG NZ Super, why not ACC?
This isn’t a private/versus public argument. Both are public.
If you are suggesting that the ACC could be more efficient (even more generous) that may be a good idea but doesn’t require ACC to be fully pre-funded. As I suggest in the paper, a PAYG ACC could even compete with private providers, if that’s what we decide is a good idea. I don’t agree with that proposition but PAYG isn’t a barrier to the introduction of competition – neither is full pre-funding.
Vote: