Abstract
This Selected Issues paper and Statistical Appendix on Ireland examines the productivity growth in Irish traded and nontraded goods, and provides some rough estimates of the sort of wage and inflation differentials that would be predicted by a Balassa–Samuelson framework under certain growth assumptions for the future. The paper provides a framework for judging what sort of wage growth and inflation could be sustained over the medium term without leading to a loss of competitiveness. The paper also examines traded and nontraded productivity in Ireland.
III. General Government Fiscal Position and Future Pension Liabilities28
A. Introduction
1. Both of Ireland’s publicly financed pension systems—the social welfare and the public service—are entirely pay-as-you-go based, and no provisions have been made to meet future pension liabilities.29 Several options are possible with regard to financing these liabilities: (i) reduce the general government debt, and hence the future interest burden leaving room to support higher pension costs in the future; (ii) fund pension liabilities through a notional fund within general government; and (iii) fund pension liabilities through an independently managed fund with a fixed charge to the budget. 30 The Irish authorities have indicated interest in taking advantage of their current substantial fiscal surpluses to fund future pension liabilities.
2. This note provides a rough evaluation of the government’s fiscal position adjusted for future pension expenditures. The assessment is based on two types of calculations: (i) the net present value of the profile of net pension expenditure over 1998–2047, indicating the stock of future pension liabilities; (ii) the additional resources needed annually to fund (or cover) future pension liabilities.
3. The estimations in this paper, based mainly on two government pension studies, suggest that accounting for future pension liabilities would have a significant impact on the reported fiscal position. The reported government fiscal surplus would be significantly lower, or disappear altogether, while the government debt ratio would rise by over 120 percent of GDP.31 These calculations are intended to assess the extent to which the pension systems are self-sufficient, and what could be done today in order to avoid an excessive burden of pension expenditures in the future.
4. The next section of this paper provides an overview of Ireland’s pension system; the third section gives a summary of the long-term demographic projections; the fourth section describes the estimation of net future pension liabilities and demonstrates the implications for the fiscal position in terms of both the government debt ratio and the adjusted general government balance. Conclusions are provided in the last section.
B. Pension System in Ireland
5. The old-age pension system in Ireland is a two-pillar system—the social welfare pensions constitute the first pillar, and voluntary supplementary (mostly occupational) pensions are included in the second pillar. The unfunded, pay-as-you-go social welfare pension scheme provides contributory and noncontributory benefits. Contributory pensions are paid to those who qualify on the basis of pay-related social insurance (PRSI) contributions, while noncontributory pensions are means-tested benefits for those who do not qualify for PRSI contributions. Although there is no formal indexation commitment, social welfare pensions are adjusted annually to reflect, at a minimum, price inflation. However, reflecting the government’s commitment to raise pensions to IR£100 per week by 2002—slightly in excess of the estimated subsistence threshold—social welfare pensions in recent years have been growing broadly in line with average industrial earnings, or even slightly above. Average replacement rate in Ireland is somewhat lower than in other major industrial countries, but above that in the United Kingdom.32
Pension Replacement Rates 1/
(In percent)
The replacement rate for Ireland is a 1999 estimate; replacement rates for other countries are projections for 1995.
Pension Replacement Rates 1/
(In percent)
| Ireland | 29.6 |
| Major industrial countries | 37.5 |
| United States | 38.5 |
| Germany | 52.0 |
| United Kingdom | 17.5 |
| Canada | 29.2 |
| Sweden | 39.0 |
The replacement rate for Ireland is a 1999 estimate; replacement rates for other countries are projections for 1995.
Pension Replacement Rates 1/
(In percent)
| Ireland | 29.6 |
| Major industrial countries | 37.5 |
| United States | 38.5 |
| Germany | 52.0 |
| United Kingdom | 17.5 |
| Canada | 29.2 |
| Sweden | 39.0 |
The replacement rate for Ireland is a 1999 estimate; replacement rates for other countries are projections for 1995.
6. Currently, almost 90 percent of individuals over 66 years of age receive social welfare pensions, 58 percent of whom draw contributory benefits. It is expected that the share of those entitled to contributory benefits will increase to 86 percent in 2016, owing primarily to the increased female participation in the labor force.
7. Occupational pension schemes can be grouped into unfunded public service schemes, privately funded occupational schemes, and individual personal pensions, usually arranged by self-employed individuals. Occupational schemes are voluntary, and employers are not legally responsible for their provision. Occupational schemes cover only 46 percent of the total number of people at work, and this number has been gradually declining, owing to the surge in the number of people working part-time or on a temporary basis.
8. The coverage by occupational pensions is significantly higher in the public sector than in the rest of the economy, owing primarily to the mandatory nature of the public sector pension schemes. The public sector pension scheme is a defined benefit scheme, providing about three-fourths of the final pensionable pay.
9. Social welfare pensions are financed out of the PRSI contributions, government contributions toward means-tested benefits, and a budget transfer covering the deficit on contributory pensions. Public sector pensions are a part of the public service pay bill, with the costs met from current revenue and employee contributions. Civil servants who were appointed prior to April 1995 do not make contributions to either pension scheme, but those who were appointed after this date are subjected to full PRSI contributions, since their pensions are coordinated with the social welfare system.
C. Long-term Demographic Changes
10. Currently Ireland’s pension costs are significantly lower than those in other OECD countries, owing primarily to its favorable demographic profile and relatively modest level of benefits. However, the demographic profile of the population is projected to change significantly after 2020, which would translate into an increase in dependency ratios.
Dependency Ratios 1/
Citation: IMF Staff Country Reports 1999, 108; 10.5089/9781451818772.002.A003
Source: Actuarial Review of Social Welfare Pensions.1/ The old-age dependency ratio is the percentage share of people over age 65 to the working age group. The overall dependency ratio is the share of all dependents, including children of 0–19 years of age and people over age 65, to the working age population.11. Over the next decade, the financing of pension expenditures would not overburden public finances: the share of the working age people in the total population is projected to rise, while the share of those over 65 would slightly decline. Financing of pension benefits will become costlier after 2015 for public service pensions and after 2020 for social welfare pensions—when the decline in the share of working age population will be combined with an increase in the share of people over 65 years of age.
12. By the middle of the next century the old-age dependency ratio is projected to increase sharply, and is likely to come close to those of other developed economies. These projections, however, are subject to a significant margin of error, owing to an uncertainty about net migration flows.
D. Estimation of Fiscal Implications
13. The analysis and estimates in this note are based on the Actuarial Review of Social Welfare Pensions (1997) and the Interim Report of the Commission on Public Service Pensions to the Minister for Finance (1997). These studies were not a response to a crisis, but a timely consideration of policy options to ensure that in the longer-term Ireland will not face difficulties similar to those being experienced elsewhere. For this reason estimates of net future pension liabilities are comprehensive in the sense that they do not account for government transfers and consider liabilities with respect to noncontributory pensions as a part of social security, rather than social welfare expenditure. The results of both studies suggest that the contribution rates would have to be increased significantly in the future, unless funding of future pension costs is started today.
14. The estimates are very sensitive to the position of the pension system at a staring point. This note reports the results of the estimates based on two assessments of the consolidated pension deficit in 1999: (i) the projection of the pension deficits produced by the Actuarial Review and the Interim Report, which amounted to 1.8 percent of the ESA95 GDP, and (ii) the pension deficit—estimated from the 1999 budgetary projections of the social insurance fund and public service pensions—which is expected to be 1 percent of GDP.33
15. The Actuarial Review and the Interim Report expected the social welfare pension deficit to be larger than that of the public service scheme—1 percent and 0.8 percent of GDP, respectively. Pension contributions of the social welfare and public service pension systems of 2.2 percent of GDP and 0.3 percent of GDP, respectively, were insufficient to finance pension costs of 3.2 percent of GDP in the case of social welfare system, and 1.1 percent of GDP in the case of public service scheme.34
16. However, according to the calculation of the pension deficit from budgetary projections (1 percent of GDP), public service pension deficit (0.6 percent of GDP) is expected to exceed that of the social welfare system (0.4 percent of GDP). The public sector pension deficit, however, is likely to be underestimated for two reasons: (i) it is based on the central government statistics, and thus does not include pension expenditure of the local authorities, and (ii) available data do not allow pension contributions to be separated from the European Social Fund receipts, both of which had been reported in the budget statistics under the same heading. The combined contributions and European Social Fund receipts amount to 0.3 percent of GDP, while the cost of the public service pension system is expected to be close to 1 percent of GDP. The deficit of the social welfare system was estimated as a difference between total pension outlays (2.4 percent of GDP), including noncontributory benefits and administrative costs, and residual contributions applied to pensions (2.0 percent of GDP), estimated as a difference between total PRSI contributions net of nonpension expenditure. It is also important to note that the economy has been operating above potential, and contributions that are currently inflated by the cycle would weaken in a long run.
Assumptions
17. The calculation of future pension net cash outflows in this note incorporates the assumptions and the methodology of the Actuarial review, and those of the Interim Report. (See table below.) Growth in average earnings was assumed to be independent of GNP growth and had been kept constant throughout the period in both studies.
Summary of Underlying Assumptions
Constant terms (1996 prices)
Growth in public service average earnings does not reflect career progresssion increases of 0.5–2.5 percent per annum.
Summary of Underlying Assumptions
Constant terms (1996 prices)
| Public Service | Social Welfare | ||
|---|---|---|---|
| Growth in real GNP | |||
| 2001–2006 | 5 percent | 5 percent | |
| 2007–2016 | 3 percent | 3 percent | |
| 2017–2047 | 2 percent | 2 percent | |
| Growth in average earnings | 1.5 percent 1/ | 2 percent | |
| Growth in pension benefits | 1.5 percent | 2 percent | |
Growth in public service average earnings does not reflect career progresssion increases of 0.5–2.5 percent per annum.
Summary of Underlying Assumptions
Constant terms (1996 prices)
| Public Service | Social Welfare | ||
|---|---|---|---|
| Growth in real GNP | |||
| 2001–2006 | 5 percent | 5 percent | |
| 2007–2016 | 3 percent | 3 percent | |
| 2017–2047 | 2 percent | 2 percent | |
| Growth in average earnings | 1.5 percent 1/ | 2 percent | |
| Growth in pension benefits | 1.5 percent | 2 percent | |
Growth in public service average earnings does not reflect career progresssion increases of 0.5–2.5 percent per annum.
Profile of net pension expenditures
18. The profile of net pension expenditures is derived by applying the assumptions to the starting pension balances. The figure below illustrates this profile as estimated by the Actuarial Review and the Interim Report (corresponding to a starting balance of 1.8 percent of GDP).
Pension Deficits
(In percent of GDP, 1999 prices)
Citation: IMF Staff Country Reports 1999, 108; 10.5089/9781451818772.002.A003
19. As indicated by the figure above, net pension expenditure growth is expected to accelerate after 2015, which initially would be caused by the retirement of the major cohort of public servants, and after 2020–25 by the increase in the old-age dependency ratio. Although the net present value of pension liabilities can be estimated from this profile, the Actuarial Review and the Interim Report did not estimate them explicitly.
20. However, two consultants for the government, Peter Bacon and Associates and Brian Duncan of Mercers have estimated accrued net pension liabilities at 107 percent of GDP. Of this some 74 percent of GDP is estimated to be due to the social welfare system and the residual 33 percent of GDP due to the public service pension system.35
Alternative estimates of government debt
21. The table below presents four estimations of the general government debt, taking into account the net present value of pension liabilities under different assumptions about the initial period balances and discount rates. The discount rate level and the first period pension balance are the only two factors that differ in these estimations. The first period pension deficit in Estimations 1 and 2 is the projection of the Actuarial Review and of the Interim Report, while in Estimations 3 and 4 it was derived from the 1999 budgetary projections. Gross debt is defined as the actual general government debt to GDP ratio at end-1998. Net debt including social security assets is estimated as a gross debt net of external reserves of the central bank (the social security system does not have any assets). Net future liabilities of the pension system is the stock of pension debt as of end-1998. These liabilities are calculated as the net present estimated value of the profile of net pension costs and include both accrued and future pension liabilities of the government.
General Government Debt in 1998
(In percent of GDP)
Net debt is estimated as gross general government debt net of external reserves of the central bank.
Net debt including net future pension liabilities is the sum of the net debt including social security assets and net future pension liabilities of the government
General Government Debt in 1998
(In percent of GDP)
| Estimation 1 | Estimation 2 | Estimation 3 | Estimation 4 | ||
|---|---|---|---|---|---|
| Initial parameters: | |||||
| Real discount rate (In percent) | 4.0 | 2.5 | 4.0 | 2.5 | |
| First period pension balance (1999) | −1.8 | −1.8 | −1.0 | −1.0 | |
| Gross debt | 52.6 | 52.6 | 52.6 | 52.6 | |
| Net debt including social security assets 1/ | 42.9 | 42.9 | 42.9 | 42.9 | |
| Net future pension liabilities, of which | 117.8 | 174.0 | 80.0 | 119.6 | |
| Social welfare | 71.8 | 109.2 | 45.1 | 70.3 | |
| Public sector | 46.0 | 64.8 | 34.9 | 49.3 | |
| Net debt including net future pension liabilities 2/ | 160.7 | 216.9 | 122.9 | 162.5 | |
Net debt is estimated as gross general government debt net of external reserves of the central bank.
Net debt including net future pension liabilities is the sum of the net debt including social security assets and net future pension liabilities of the government
General Government Debt in 1998
(In percent of GDP)
| Estimation 1 | Estimation 2 | Estimation 3 | Estimation 4 | ||
|---|---|---|---|---|---|
| Initial parameters: | |||||
| Real discount rate (In percent) | 4.0 | 2.5 | 4.0 | 2.5 | |
| First period pension balance (1999) | −1.8 | −1.8 | −1.0 | −1.0 | |
| Gross debt | 52.6 | 52.6 | 52.6 | 52.6 | |
| Net debt including social security assets 1/ | 42.9 | 42.9 | 42.9 | 42.9 | |
| Net future pension liabilities, of which | 117.8 | 174.0 | 80.0 | 119.6 | |
| Social welfare | 71.8 | 109.2 | 45.1 | 70.3 | |
| Public sector | 46.0 | 64.8 | 34.9 | 49.3 | |
| Net debt including net future pension liabilities 2/ | 160.7 | 216.9 | 122.9 | 162.5 | |
Net debt is estimated as gross general government debt net of external reserves of the central bank.
Net debt including net future pension liabilities is the sum of the net debt including social security assets and net future pension liabilities of the government
Alternative estimates of the government balance
22. In order to obtain an estimate of the additional fiscal resources needed annually to fund pension liabilities, this section considers two hypothetical options facing the government (see table below). The first is the full coverage of future pension liabilities which requires the net pension debt to be driven to zero by the end of the estimation period (2047). The cost under this option is the amount of resources needed annually to fully amortize the debt. The second option is partial coverage, which assumes that the pension debt is kept constant in real (1999) terms throughout the period. The cost under this option is the amount of resources needed annually to cover interest cost and to prevent the build-up of additional pension debt. Additional resource needs are computed as the difference between the cost of either option and the current pension balance, which is already reflected in the government’s fiscal position. In other words, it is the amount of additional resource transfers required annually under each option to cover the cost of future pension liabilities. And finally, the adjusted general government balance represents the actual general government balance net of the annual resource need. As the table indicates, the financing requirement under either option depends strongly on the current pension balance and the level of the discount rate.
Cost of Future Pension Liabilities
(In percent of 1999 GDP)
Reflects resources required to drive net pension liabilities to zero by the end of the period (2047).
Additional resource need is the cost of full coverage adjusted for the pension deficit already recorded in the general government balance.
The general government balance adjusted for the cost of covering pension liabilities.
Reflects resources required to keep pension debt constant in real terms.
Cost of Future Pension Liabilities
(In percent of 1999 GDP)
| Estimation 1 | Estimation 2 | Estimation 3 | Estimation 4 | ||
|---|---|---|---|---|---|
| Real discount rate | 4 percent | 2.5 percent | 4 percent | 2.5 percent | |
| Full coverage of pensions | |||||
| Cost 1/ | 5.3 | 6.0 | 3.6 | 4.2 | |
| Current pension balance | −1.8 | −1.8 | −1.0 | −1.0 | |
| Additional resource need 2/ | 3.5 | 4.2 | 2.6 | 3.2 | |
| Adjusted general government balance 3/ | −0.8 | −1.5 | 0.1 | −0.5 | |
| Partial coverage of pensions | |||||
| Cost 4/ | 4.7 | 4.3 | 3.2 | 3.0 | |
| Current pension balance | −1.8 | −1.8 | −1.0 | −1.0 | |
| Additional resource need 2/ | 2.9 | 2.5 | 2.2 | 2.0 | |
| Adjusted general government balance 3/ | −0.2 | 0.2 | 0.5 | 0.7 | |
| Memorandum items: | |||||
| Actual general government balance expected in 1999 |
2.7 | 2.7 | 2.7 | 2.7 | |
| Net present value of future pension liabilities |
117.8 | 174.0 | 80.0 | 119.6 | |
Reflects resources required to drive net pension liabilities to zero by the end of the period (2047).
Additional resource need is the cost of full coverage adjusted for the pension deficit already recorded in the general government balance.
The general government balance adjusted for the cost of covering pension liabilities.
Reflects resources required to keep pension debt constant in real terms.
Cost of Future Pension Liabilities
(In percent of 1999 GDP)
| Estimation 1 | Estimation 2 | Estimation 3 | Estimation 4 | ||
|---|---|---|---|---|---|
| Real discount rate | 4 percent | 2.5 percent | 4 percent | 2.5 percent | |
| Full coverage of pensions | |||||
| Cost 1/ | 5.3 | 6.0 | 3.6 | 4.2 | |
| Current pension balance | −1.8 | −1.8 | −1.0 | −1.0 | |
| Additional resource need 2/ | 3.5 | 4.2 | 2.6 | 3.2 | |
| Adjusted general government balance 3/ | −0.8 | −1.5 | 0.1 | −0.5 | |
| Partial coverage of pensions | |||||
| Cost 4/ | 4.7 | 4.3 | 3.2 | 3.0 | |
| Current pension balance | −1.8 | −1.8 | −1.0 | −1.0 | |
| Additional resource need 2/ | 2.9 | 2.5 | 2.2 | 2.0 | |
| Adjusted general government balance 3/ | −0.2 | 0.2 | 0.5 | 0.7 | |
| Memorandum items: | |||||
| Actual general government balance expected in 1999 |
2.7 | 2.7 | 2.7 | 2.7 | |
| Net present value of future pension liabilities |
117.8 | 174.0 | 80.0 | 119.6 | |
Reflects resources required to drive net pension liabilities to zero by the end of the period (2047).
Additional resource need is the cost of full coverage adjusted for the pension deficit already recorded in the general government balance.
The general government balance adjusted for the cost of covering pension liabilities.
Reflects resources required to keep pension debt constant in real terms.
E. Conclusion
23. Pension costs in Ireland are expected to increase significantly in the long run. The current favorable position in terms of pension costs is projected to fade away over the next two decades, when the country will start to undergo the effects of the aging of its population.
24. The lack of consideration of accrued and future pension liabilities as a complement to current government finance accounts understates the stock of the government debt and could create an illusion of greater wealth, raising current consumption in excess of its long-term equilibrium level. The burden of higher pension costs in the future can be eased by their advanced funding, and the current strong fiscal position provides an opportunity for the government to smooth the burden of pension costs overtime. Estimates in this paper indicate that covering of pension liabilities will require 2½−3½ percent of GDP in additional fiscal resources—essentially wiping out the current fiscal surplus.
REFERENCES
Chand, Sheetal, and Jaeger, Albert, 1996, Aging Populations and Public Pension Schemes, (Washington: International Monetary Fund).
Commission on Public Service Pensions, 1997, Interim Report to the Minister for Finance, Dublin.
Irish Pensions Trust, 1997, Actuarial Review of Social Welfare Pensions, Dublin.
The Pensions Board, 1998, Securing Retirement Income: National Pensions Policy Initiative, Report of the Pensions Board to the Minister for Social, Community and Family Affairs, Dublin.
Prepared by Natasha Koliadina.
Pay-as-you-go pensions are paid out of current tax revenues, rather than out of an accumulated fund.
Under ESA 95, notional funds within the control of the government do not affect the fiscal balance. However, payments made to an independently managed pension fund outside government could be considered current expenditures, thereby reducing the fiscal balance.
Based on revised (ESA95 basis) GDP. This corresponds to 130 percent of GDP under the orginal GDP estimates.
The replacement rate is defined as an average pension benefit in percent of gross average industrial earnings.
The consolidated pension deficit is the sum of deficits of the social welfare and public service pension systems. Calculations in both studies are based on GNP. In this note all ratios are shown as a share of ESA95 GDP.
The Actuarial Review of Social Welfare Pensions assumed that only 62.5 percent of total pay-related social insurance contributions would go toward the cost of pension benefits.
Accrued pension liabilities are pension costs to which the government has already commited itself. They reflect accumulated liabilities of the government with respect to those who are already enrolled in the system. This estimate neither includes any pension liabilities, which the government can incur in the future, nor contributions.
