Richard Bruton's contribution to the Second Reading on AE in the Dail

[Duke of Marmalade]

Richard Bruton:
The question of whether it makes sense to have the pension fund split into individual pension accounts with their own risk management profiles and investment strategies has been raised. I am quite persuaded by the argument that, for a fund like that proposed, which is to be managed centrally by the auto-enrolment board, there is a strong case for a policy to maximise the return to the fund in which people would own units. The units would be based on their contributions. People do not need to have a personal account that goes into lower risk as they approach retirement. They simply should be realising their units. Those units will have a fairly stable value within an overall portfolio managed by the fund. The fund should do the anticipation, and if it needs to put a floor under those elements that are going to mature at an early date, it should be done at general fund level. There should be an approach whereby we seek to maximise the return on the investment and take advantage of the economies of scale that a large central fund manager would result in. One would not see a private pension fund breaking up the management of its fund into individual pieces for each worker; it would not see that as sensible. It would manage the fund and provide an annual return to everyone based on its performance, not the performance of everyone's individual piece of it. It would not ask people to make decisions on whether they wanted a low-, medium- or high-risk strategy; they would be using an overall strategy. That would reduce management fees and reporting costs and improve overall performance. I remain to be persuaded on why we are opting for a very unusual approach in which people would have an individual classified fund as opposed to owning units in a larger fund.

 

[Duke of Marmalade]

Wow! More power to Richard. He seems to have actually read the independent evaluation of Colm's proposal despite the almost totally successful efforts of the Pension Council to bury it.

 

[Dr Strangelove]

If I read Richard Bruton correctly he basically wants a single fund in which individuals own notional shares rather than a hypothecated personal fund.


This would take the advantage of exonomiiws of scale and higher long-term returns from a long default high-risk strategy. It would have none of the drawbacks of smoothing based on model-based parameters that will inevitably be wrong.

It also means the fund can be wound up without state bailout which is one of the main reasons for having it.

 

[Colm Fagan]

@Dr Strangelove. I don’t know what you’re saying. Richard Bruton is articulating my proposal. What do you mean by ‘model-based parameters that will inevitably be wrong’? You’ve lost me. Also, are you saying that my proposal isn’t as safe as Richard’s? Why? I have to keep pointing out your misunderstandings.

 

[Dr Strangelove]

What do you mean by ‘model-based parameters that will inevitably be wrong’?

Your famous “smoothed return” which will use model-based parameters.

If you read closely Richard Bruton doesn’t think this is essential.

 

[Fortune]

Your famous “smoothed return” which will use model-based parameters.

If you read closely Richard Bruton doesn’t think this is essential.

From reading Richard Bruton, it seems he doesn't have an entirely correct view of his pension funds work

 

[Colm Fagan]

@Fortune In fairness to Richard Bruton, he's a politician. We don't expect him to be a pensions expert. I was referring mainly to his insight that it makes no sense for each individual in an AE scheme to have their own individual risk management profile and investment strategy.

@Dr Strangelove. The word "model" appears three times in my entry to the Institute and Faculty of Actuaries' competition. All three refer to the Longevity Protection Fund, which requires a model for assumed future mortality. There are no "model-based parameters" for the smoothing formula. I suggest you read my paper for the IFoA competition, and my later enhancements, as set out in my draft responses to The Pension Council's RFQ, which can be found here.

 

[Dr Strangelove]

@Dr Strangelove. T There are no "model-based parameters" for the smoothing formula. I suggest you read my paper for the IFoA competition, and my later enhancements, as set out in my draft responses to The Pension Council's RFQ, which can be found here.

In your paper you say:

On (ii) above (the weighting “p” for current market value in the smoothing formula), the paper in Appendix B includes the paragraph (in Section 6):

There are also coefficients in the Japan spreadsheet which produces the smoothing. Maybe we shouldn't quibble about the term "parameter" but this is what they seem like to me: models of past performance which are used as assumptions for future returns (absolute rate and volatility of).

Anyway my questions are:

1. Who decides which coefficients should be used in the smoothing formula? What is the governance around this?
2. What if (over decades) the formula is too pessimistic producing a surplus?
3. What if (over the decades) the formula is too optimistic producing a deficit?
4. The current AE proposal can have a change of strategy or even be wound down with no major impact. Your "smoothed return" approach would be perpetual in nature. How would it be wound up in fifty years without major state involvement?

I have asked these questions before! I'd love if you could answer succinctly and point by point and not in meandering paragraphs which is your tendency. You are not under any obligation of course, it's your time and I am just an anonymous pseudonym on the internet! As I've said before there is huge merit in the majority of your proposal but elements but in may respects it does not de-risk the public finance sustainability which is one of the main objectives of it.

 

[Duke of Marmalade]

Anyway my questions are:

1. Who decides which coefficients should be used in the smoothing formula? What is the governance around this?
2. What if (over decades) the formula is too pessimistic producing a surplus?
3. What if (over the decades) the formula is too optimistic producing a deficit?

These are very valid questions and Colm has accepted that there would need to be continual oversight by a truly independent and multi-disciplinary panel of experts. This is what Dr Fitzgerald (the independent expert) says:

The Alternative AE Proposal would likely produce significantly higher pensions for those contributing into the scheme. There are significant upside benefits for those who would opt to stay enrolled, with estimated pensions being roughly twice as high as from schemes in other OECD countries.
From the State’s perspective, higher projected pensions would also increase expected future income tax revenue. The Alternative AE Proposal would likely be more attractive than approaches in other OECD countries and would likely result in higher levels of members opting to stay enrolled, resulting in higher future pension coverage.
The risks arising are analogous to those arising from the introduction of the European single currency. There is considerable upside, but the risks need to be managed, and most importantly the scheme would need to be stood behind in times of turbulence, just like with the Euro. There are several options available to the State to (directly or indirectly) stand behind it that would enable prudent management of the risks involved, either providing a backing itself, or using the market to hedge the risk or appointing a person of appropriate character to manage it, or a combination of these.

(My emphasis,) There is clearly a need for further investigation before proceeding (or otherwise) with a proposal with such upside promise. How on earth did the PC take it on themselves to shut down debate in the face of this overwhelmingly supportive independent evaluation?

1. The current AE proposal can have a change of strategy or even be wound down with no major impact. Your "smoothed return" approach would be perpetual in nature. How would it be wound up in fifty years without major state involvement?

I will leave it to Colm to address this more fully but my understanding is that he has elaborated on exactly when and how the fund would be wound up.

 

[Colm Fagan]

I'd love if you could answer succinctly and point by point

Delighted to oblige. Just look up the words "committee of eminent economists" in this document for answers to your first three questions.
The answer to your fourth question can be found at the bottom of page 15, top of page 16 of this document.
Is that succinct enough for you?

 

[Duke of Marmalade]

From reading Richard Bruton, it seems he doesn't have an entirely correct view of his pension funds work

I agree that it doesn't seem to gel in parts but I think it is much better informed than it appears at first sight. Take the following description of how it works:

The units would be based on their contributions. People do not need to have a personal account that goes into lower risk as they approach retirement. They simply should be realising their units.

It is the reference to "units" that was a cause of confusion for me. I interpreted this as meaning contributions would buy units at their current price - which is unit linking. But I think it means exactly what Colm is talking about. Their personal account will be their contributions to which would be added, on say a quarterly basis, their "interest". Unit linking could be operated like that but the interest would be all over the place, but more importantly would need to be added daily. I think Richard is talking precisely about Colm's proposal. I am sure Richard is a bright guy but the impression I get is that his contribution owes something to well informed advisors. What a pity he isn't the Minister of Social Protection.