National Pensions Reserve Fund: An Bord Snip Nua

A remarkable recommendation from An Bord Snip Nua is to suspend payments into the National Pension Reserve Fund (NPRF).  In  today’s Irish Times,  Fintan O’Toole comes out in support of this proposal (see his article here).  The relevant text from the report is:

D.2  Suspend payments into the National Pension Reserve Fund

Under the National Pensions Reserve Fund Act 2000, one per cent of GNP is paid into the NPRF each year.  The Group considers that continuation of this annual payment is difficult to justify at this time, given the rate of growth of the public sector borrowing requirement.  These payments were affordable when the budget was generally in balance but the Group considers they should be suspended as the State is in effect borrowing to finance the purchase of financial instruments.Transfers to the NPRF amount to approximately €1.6bn a year.  Suspending this €1.6bn transfer would have no impact on the General Government Balance, but would reduce the annual Exchequer Borrowing Requirement.

(page 182 of second part of report)

It is odd that the NPRF falls within the remit of a report on public expenditure, since payments into the Fund do not constitute public spending as it is normally understood. Rather, the Fund is a vehicle to enable partial pre-funding of the projected sizeable increase in future public spending that is connected to the ageing of the population.  The logic of pre-funding follows from ‘tax smoothing’ principles – it is better to have a higher tax burden now in order to make payments into the Fund rather than to experience a discrete jump in the tax burden in the future. The annual payment into the Fund is also an important commitment device, especially during periods of scarce fiscal resources. In particular, the Fund protects the interests of those who will be paying taxes in the post-2020 period versus those who have a much shorter horizon.

There is certainly plenty of room to discuss the appropriate investment strategy for the Fund, especially when the government is running a deficit and there is a sizeable risk premium embedded in the yield on Irish sovereign debt.   Moreover, the ad hoc revision of the Fund’s investment strategy to enable its investments in the main Irish banks provides a further reason to re-think the strategy for the Fund.

One dimension of this review could include the Fund’s strategy vis-a-vis Irish government debt. Although the founding legislation for the Fund prohibited the purchase of Irish government debt, this prohibition could be reviewed.  Just as the US Social Security Fund holds only US treasury bonds and retirement funds in other countries have a heavy concentration in domestic government debt, it may make sense for the Fund to have the option to purchase Irish government debt under certain conditions.  This is also in line with the trend towards localisation in investment decisions, as described by Gillian Tett in the FT yesterday (her article is here).

16 replies on “National Pensions Reserve Fund: An Bord Snip Nua”

Thanks Philip for raising this important issue.

I think the tale of the building up and subsequent spending of our pension reserve fund will be a cautionary one for other governments interested in doing this kind of thing. The idea was to take deliberate actions to set aside a separate fund that could be spent in the future when the demographic trends were less favourable.

However, I think now that this objective could have been better achieved simply by running larger surpluses (smaller deficits) to the tune of 1 percent per year. Whatever about re-capitalising the banks, it is far less likely that Irish politicians would be calling for an increase in government net debt to spend on infrastructure projects or the various other items that have been seen as a good use of the fund—the fund is seen simply as a free stash of money, whereas borrowing more funds is accepted as having a cost, despite the actual symmetry in terms of effects on our net debt position.

So really all of this comes down to political economy. I believe the reason Finance officials liked the idea of the NPRF was that its existence made it more likely that underlying surplus would be one percent larger during the boom—and when we return to growth, it will again be difficult to get electorally-minded politicians to focus on the very long run. However, we now know that this approach also made it more likely that the fund would be blown on stuff it was not intended for. This raises the question of what is the best mechanism to get governments to run the larger surpluses necessary to cope with demographic ageing, while keeping the fund protected during cyclical downturns.

Your suggestion of having the fund buy Irish government debt might work better at preventing its running down during any future crisis—if our fund held Irish government IOUs, then I suspect the government would have to explain during any future crisis that it doesn’t want to test the market for sovereign debt by selling off an extra €20 billion of government bonds (ostensibly these would be secondary market sales, but in reality they’d be closer to new bond issuance.)

I see it differently, as you might expect. They are busted, flat broke, so they sell off whatever they can that doesn’t cost votes ….. So, instead of raising taxes now, yes, losing them votes, they go back on their own solemn promises citing their own abysmal management and introduce a new law, (see how easy this is when votes are at stake?) to enable them to pass the politically unpopular decision to another government. Probably not them, which makes it even more attractive. Any more promises left to break? Let’s see. By December we should know how the depression is going, worldwide.

Let us hope the new law enables them to stuff all their worthless paper into this fund, otherwise they will have to use up more time for another new law!

Seems to me that, globally speaking, saving to fund future pensions will only work if the investments financed therewith yield a positive return for future generations. Otherwise, future savings will just chase a depleted stock of future production; old money will be inflated away visavis the value of the new money, and the old fixed income pensioners will be as poor as if they had never saved a penny.

So what matters is not the size of the “fund”, but the quality of the investment. Which brings us to the suggestion to buy Philip’s Irish goverment junk bonds.

If pension fund money is “invested” in Irish government bonds which are being issued in order to overpay for NAMA assets (unproductive, crappy development sites in the hinterlands of Dublin), this is not providing any meaningful investment in the future.

So if we want to help ourselves pay for our old age with money earned today, the question should be, what can we buy now that will create value in the future? And if there is a justification for the goverment making that purchase on our behalf, you have to prove the market failure.

One obvious future public good to pay for is the current stock of children. The better they are educated, loved and clothed, the better they are schooled, the more able they will be to pay for us when we are old.

So use the NPRF funding to offset the effects of cuts in education instead of bailing out greedy bank stakeholders. Radical suggestion?

@Philip Lane

“The logic of pre-funding follows from ‘tax smoothing’ principles – it is better to have a higher tax burden now in order to make payments into the Fund rather than to experience a discrete jump in the tax burden in the future.”

Maybe from the viewpoint of a public sector worker to protect the costly Rolls-Royce pension arrangements.

From the viewpoint of private sector workers, including the majority without an occupational pension, already paying for unjustified benchmarking, what would justify accepting an additional burden now because the State is unwilling to change the existing public sector pension arrangements ?

The Dept of Finance says pensions now account for 10.7% of the total Pay and Pension Paybill, up from 9.1% in 2004. Overall, the pensions bill has increased from €1,256m in 2004 to €1,966m in 2009 representing a 56.5% increase over the period (pay in contrast rose by 31.8%); the increase in the health sector pension bill has been 48% over the period.

Changing the crazy system of indexing pensions to current pay, appears to be a reform too far for the insiders.

I assume the issue of frontloading contributions to cover the bank recaps arose because shares would otherwise have had to be sold when markets were at 12-year lows at one stage.

I dont agree with Fintan O’Toole on much, but i agree with him on the basic premise that its madness to borrow money at the current rates to fund the NPRF. His arguments make even more sense when you consider that every marginal Euro we invest in the NPRF right now is actually more expensive to borrow than the last (ie as our funding/deficit requirements increase, so does the premium on the debt). As such, there’s a fairly compelling argument to be made that the long term funding of the NPRF is better served by dealing with the more immediate short term fiscal crisis, no?

Could someone please set out the options and implications of O’Toole’s suggestion in as objective as possible terms in the current crisis.

On the face of it what he says makes sense. The complicating factors seem to be realisation of NPRF funds in the current market situation and whether a “painless” (today, whatever about tomorrow) solution of the immediate problem will do nothing to change behaviour/costs and so just postpone the ongoing required deficit adjustment for a year or two?

Forgive my cnyical nature but I suspect there’s a sleight of hand going on with this payment (anf forward payment too) of money into the NPRF that none of us have yet put our finger on. Our politicians are not as daft as we would sometimes like to think…. never underestimate….. etc.

Pat Donnelly is making an important point. What did “commitment” ever mean in the Irish context where anything can be rammed through the Oireachtas on guillotines and whip votes? As long as we have the sheep FF backbenchers that we have, the future is as long as the arrival of the next “crisis”.

Philip Lane describes the Bord Snip recommendation, that the annual contributions to the NPRF be suspended, as ‘remarkable’, and he argues against this course, suggesting instead a review of investment strategy. My personal view is that the fund should never have been set up in the first place, and should be wound down.

It is a misunderstanding to infer any of the following from the improvement in life expectancy:

(i) that this development constitutes a demographic crisis, or even ‘ageing of the population’ in any economically meaningful sense;

(ii) that a problem of intergeneralional equity is necessarily created;

(iii) that Governments should respond by ‘pre-funding’ through running budget surpluses, and investing the proceeds.

on (i): It’s not a demographic crisis. The Black death was a demographic crisis. This is just a policy problem, because we have fixed retirement ages and other inflexible and out-moded systems of providing retirement income. It is not even clear that the population is ‘ageing’ in any sense that should engage economists: is a 70-year-old in 2009 older that a 60-year-old was fifty years ago?

on (ii): Why, aside from current institutional arrangements capable of being altered (and currently being altered at a rapid pace in many countries) does an increase in life expectancy at all ages produce intergenerational equity problems?

on (iii): Any manoeuvre which sees an indebted Government taxing more now to run surpluses instead of retiring debt, or borrowing, is just a long/short hedge fund strategy on behalf of the public. The Government at the margin goes short bonds and (in the NPRF case) long equities. The public is perfectly free to choose this strategy for itself, but is rarely observed doing so. I am not making the cheap point that the long-equities/short-bonds strategy has not been a winner for hedge funds in recent years, and that the NPRF is under water when the cost of funds is taken into account, but the cost of funds is real.

There is of course a need to ensure the sustainability of arrangements for retirement income, with measures such as higher retirement ages and better allocation of longevity and investment risk.

On all of this, see Nicholas Barr and Peter Diamond, Reforming Pensions: Principles and Policy Choices, OUP, 2008.

The NPRF contributions are relevant to public spending because the Government (like the rest of Ireland Inc) needs to de-leverage in order to avoid roll-over risk and credit spread penalties. Crudely, if we are worried about the cost impact of selling too many bonds, there are equities and other things to sell.

Philip also suggests that the Irish government should sell bonds in order to invest in, er, Irish government bonds. No additional capacity to fund pensions or anything else is thereby created unless the State’s Debt Management Office is able to run a succesful long/short strategy at the expense of the market. In current circumstances, this is a fairly exotic proposal.

Karl Whelan poses the question ‘… what is the best mechanism to get governments to run the larger surpluses necessary to cope with demographic ageing…’ This rather assumes that no other approaches are available.

The only cast-iron case I can think of for having a sovereign wealth fund is where the State unavoidably accumulates positive net assets, vide Abu Dhabi or Norway. Our rather conditional access to the bond markets is not quite oil in the ground.

Has anyone done an analysis on what out net financial position would have been had NTMA simply used all monies to pay down the national debt….

I realize there are organizational issues to such an approach but I would be surprised if NTMA had beaten this simple, low cost, risk free ‘investment’ strategy.

Thats not to say there are good people in the NTMA, they seem to have spotted the upcoming crisis earlier than most, certainly earlier than those in power.


“Has anyone done an analysis on what out net financial position would have been had NTMA simply used all monies to pay down the national debt….”

Did I hear right when the NTMA boss said recently there was no IMF intervention risk ‘cos the cash position of NTMA was so strong??

Another point of scepticism concerning the conventional wisdom on the demographic “timebomb”: female participation rates in the labour market are the single biggest variable in determining potential labour supply as a % of total population. They dwarf longetivity concerns by a far cry.

This is important, because an older (post menopause) population could imply higher female participation rates in the workforce, particularly as the passage of time pushes new, more labour-market savvy, cohorts of women into the post-childcare age bracket. Todays 55 – 65 year old Irish women are not particularly well-represented in the labour market, but the next generation’s will be, and there will be a whole inverted pyramid of them.

Emphases were misplaced while our political leaders were being economical with the truth. They wanted a slightly counter cyclical policy and so sold us the demographic timebomb. We are one of the better placed european countries to survive such an emotive explosion. Unless we drive our youngsters off shore ….

So now we revert back to reality, except not as respects insolvent banks …….. they are sacrosanct and not to be liquidated.

Colm’s post helps to clarify the thinking behind this recommendation.

I take a different view. A recurrent theme in the debate on Irish fiscal policy is the lack of institutional devices that enable a medium-term vision for fiscal policy to drive decisions. The NPRF is one such commitment device.

It is not in the least exotic for state-owned asset funds to hold domestic government debt (US Social Security Fund etc). As a long-term investor, the State can also engage in the long-short strategy, which should pay off over a long horizon under the equity risk premium hypothesis. The investment choices of individuals are not relevant, since the financial position and time horizon of the State is far different to individual investors.

It is also not clear that the bond market would view favourably a decision to cancel payments into the NPRF. Indeed, the informed opinion of the Minister for Finance is that the NPRF is viewed with favour by the markets, since it provides a signal about the commitment of the government to long-term fiscal sustainability.

The NPRF is a fairly modest initiative: much of the adjustment to the ageing of the population will indeed involve changing the retirement age and alterations to the levels of pension benefits and conditions.

The government issues bonds to finance the buying of government bonds. Makes eminent sense to me….

Surely we have views on the intemporal merits of pre funded versus PAYG pension funding.

As I recall, dynamics of demography, real interest rates and multifactor productivity are important factors (also possibly whether you are a fan of neoclassical endogenous growth models). But in dynamic equilbrium, it matters not.

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