Managing the Risks of Ageing: The Role of Private Pensions and Annuities within a Comprehensive Retirement Policy for New Zealand

Abstract

Approaching retirement, individuals are confronted by a range of future risks and uncertainties. The primary worry is insufficient income and the associated danger of outliving one's capital. New Zealand has a unique approach for reducing this risk, comprising a universal state pension supplemented by voluntary unsubsidised saving. This simple model meets poverty prevention objectives, but middle-income baby-boom cohorts may struggle to achieve their income-replacement aspirations. The modest capital they have saved to supplement the state pension is exposed to the risks of inflation, poor investment outcomes, growth in living standards, and increasing longevity. They will enter retirement with significantly less private pension provision than previous generations and while they may hold a high proportion of their assets in owner-occupied homes, this equity is not readily accessed. They and their families also face the risk that they might require costly long-term residential care in old age. Women are likely to be particularly affected, not only as the spouses of men needing care, but, because of greater average longevity, they have a higher propensity to need long-term care themselves. Pension design and annuity markets are neglected areas of inquiry in New Zealand. In part this is because international pressures to privatise the state pension by setting up compulsory savings schemes in the private sector have been resisted. This thesis outlines the historical, practical, political and theoretical factors that explain the demise of private pensions and annuities. This provides a record of international interest as New Zealand is the first developed country to institute a tar neutral environment for retirement saving. While the New Zealand model is largely a credible one, there are significant shortcomings. This thesis examines whether economic theories can cast new light on what should be done and finds the experimentation of a pragmatic kind that has gone on historically precludes highly theoretical or ideological policy solutions. Normative judgements about well-being and distribution cannot be avoided. An integrated approach to reforming the New Zealand system is explored, based on the advantages of linking certain kinds of insurance. A substantial role for the state is inescapable; especially in the annuities market, which, it is argued, should be developed to play a significant role in retirement policy options. A state-guaranteed life annuity linked to long-term care insurance financed by a combination of cash and home equity is proposed, subsidised by intragenerational transfers from the retired population. This reform proposal builds on the existing pre-retirement saving policy and keeps the state pension as the cornerstone. The pay-off is improved welfare for middle-income retirees, greater economic efficiency, lower fiscal cost and improved equity both across and within generations. A greater credibility for the New Zealand model in international forums is also likely to follow.