Section 4 - Future Cost of NZS

4.         How much will New Zealand Superannuation really cost?

The Treasury makes regular projections of expected expenditures and future growth rates of the kind referred to in section 3 above.  These must be subject to considerable uncertainties, given the long timeframes involved.  It is difficult enough to guess what Budget surpluses/deficits might look like in two or five years, never mind 20 or 40 years away.  However, it is possible to analyse trends in current policy settings by making assumptions about the future.  For example, we know the current demographic profile and so we know with some accuracy the number of 65 year-olds there will be in 20 years, after making adjustments for deaths and net migration.

The Retirement Policy and Research Centre’s 2013 PensionBriefing[13] analysed the results of 14 versions of projections made by the Treasury’s Long Term Fiscal Model (LTFM) between 2000 and 2013 and observed:

“…it is clear…that the expected future real cost of NZS measured in the 13 years covered by the NZSF models’ calculations has actually fallen, benchmarked against future estimates of GDP.  In fact, the 2060 estimate of the expected net cost of NZS has reduced from 9.7% of GDP in V1-2000 to 6.6% of GDP in V14-2013 (a reduction of 32%).  Most of that is attributable to the improvement in real GDP (+60.8% in 2060)...”[14]

The RPRC’s chart illustrates that point:

Note: the cost for years before the year a model was run are ‘actuals’; for years after the model was run, the costs are estimates expressed as a percentage of the nominal GDP in those years

Note: the cost for years before the year a model was run are ‘actuals’; for years after the model was run, the costs are estimates expressed as a percentage of the nominal GDP in those years

[13] New Zealand Superannuation’s real costs – looking to 2060 (accessible here).
[14] More recently, the Treasury has estimated the 2060 net cost of NZS at 7.1% of GDP, based on the 2016 LTFM (New Zealand Superannuation Contribution Rate Model – HYEFU Update  New Zealand Treasury, November 2016 – (accessible here).  After 14 versions of the LTFM that saw steady declines in the expected net cost of NZS, the 2016 model shows a relatively significant 7.6% increase (from a net 6.6% in the 2013 model to 7.1% in 2016).  The principal driver of this change has been new estimates from Statistics New Zealand of the growing numbers of over 65s.  Previously, the growth in this group was set at an average 1.65% a year.  That has been revised upwards to 1.85% a year.  But for that changed assumption, the estimated net cost of NZS in 2060 would apparently have been 6.6% of GDP – no change from 2013 and down from the 6.7% used in the 2016 Budget NZS model.

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The RPRC concluded that the Treasury’s projections:

“…emphasise[] the importance of economic output and, for the security of today’s and tomorrow’s pensioners, the importance of increasing that output at a faster rate than the latest version of the NZSF model presently projects.  For many more reasons than just the affordability of NZS, how to make New Zealand more productive should be at the centre of discussions about the economic implications of an ageing population.”

The government, on behalf of all taxpayers, balances competing claims on economic output from everyone, including pensioners.  The decisions are made year-by-year and can change from year to year.  With growth, governments have more choices but it’s important to emphasise that those are choices of the day, not today.

The ‘cost’ of any retirement benefits scheme is the benefits paid (plus administration costs).  That applies to any scheme – public or private; pension or lump sum; defined benefit or defined contribution.  That cost has nothing to do with the way the benefits are financed – whether they are ‘pay as you go’ or fully pre-funded (or a mix).

So, the cost of NZS is the pensions paid in the year they are paid and that is unaffected by the presence or absence of the New Zealand Superannuation Fund (we have more to say on this in section 7 below).

Today’s taxpayers and voters cannot bind taxpayers of 2060 (or 2037) to any decisions made about NZS over the next few years.  The 2060 government, acting on behalf of tomorrow’s taxpayers, could make very different decisions about the claims of pensioners (among others) on economic output and those different decisions could be implemented relatively quickly.

The annual amount of NZS in, say, 2037 will be the total amount that taxpayers of 2037 are prepared to spend on NZS divided by the number entitled to receive it in 2037.  To the extent that taxpayers are not prepared to spend as much as is now contemplated (in 2017), the annual amount to each pensioner will reduce.  That ‘political economy’ issue will have nothing to do with the amount in the New Zealand Superannuation Fund; nor the annual amount it can disburse because that will have no bearing on the cost of NZS in 2037.

That does not mean the Treasury’s projections have no value but we must understand their significance to retirement income policies in particular.  Part of that is building a degree of trust in our future.  Part of it is giving us plenty of warning about the trends under current policy settings.

However, today’s taxpayers, through the government, decide on today’s spending priorities.  A similar process will take place in 10, 20 and 40 years and nothing we say today and no institution we develop today, such as the New Zealand Superannuation Fund[15] or the decision in 2017 to increase the state pension age from 2037, can change that.

We develop or refine today’s Tier 1 pension (NZS) based on today’s conditions (sustainability, fairness etc.) and we leave it to today’s savers to make their retirement saving plans based on what we know today.  The cost projections show what that might look like in 20 or 40 years so that savers can guess the robustness of their overall expected retirement income provision (state plus private) and the contribution that NZS might make to that.  Savers can assess the robustness of their planning and as they get closer to retirement, make appropriate adjustments to private provision.

[15] See Section 7 below for more on the NZSF.

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The Treasury’s projections do not limit the possibility of changes, even quite rapid changes to public provision.  That is and must be the prerogative of taxpayers of the day but we should expect the constant and consistent flow of information to reduce the possibility of disruptive changes such as New Zealand faced over the 20 years from 1975[16].

However, taxpayers of tomorrow might resent having their hands tied in any way with respect to decisions that are theirs to make at the appropriate time and recognising the then appropriate competing demands on their taxes.  A decision today about the state pension age in 2037 could be seen, in 20 years, as a constraint on tomorrow’s decision-making process.

Similarly, the presence of the New Zealand Superannuation Fund might be seen as a constraint on future governments’ ability to make decisions about the size of NZS.  Today’s taxpayers might say they have paid more than is needed today for NZS (by the amount of the contributions to the NZSF) and might reasonably argue, when they become pensioners, that they have already partly paid for their pensions.

[16] See A condensed history of public and private provision for retirement income in New Zealand – 1975-2008, an RPRC PensionBriefing (accessible here) for a summary of the sorry history of changes during those difficult 30 years.
Questions New Zealand needs to discuss on New Zealand Superannuation’s cost

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Questions New Zealand needs to discuss on the sustainability of NZS:

  1. Are we convinced that the future cost of NZS will be the amounts paid each year and that will have nothing to do with the amount of money in the NZSF?
  2. How robust are the Treasury’s projections in the ‘Long Term Fiscal Model’ and what are the main risks to those?
  3. Why can’t we have an accessible model that allows us to see what the cost implications of different possible changes to the design of NZS?  What, for example, are the implications of the proposed changes in the state pension age?  What might happen if other aspects of the design changed?
  4. Are we clear what the purpose of the Treasury’s projections is and their significance to governments’ planning and individuals’ decisions about retirement saving?