Jane the Actuary Retirement

Forbes post, “And Now Their Watch Has Ended: Retirement in Game of Thrones, Er, The Middle Ages”

Originally published at Forbes.com on April 24, 2019.

 

Viewers and readers of Game of Thrones/A Song of Fire and Ice are no doubt familiar with the phrase used when a man of the Night’s Watch passes, just as much as will have heard/read the vow of the Night’s Watch (available online at Wikiquote.org):

Night gathers, and now my watch begins. It shall not end until my death. . .

which viewers/readers were first introduced to in season/book one.  Now it’s season 8 of Game of Thrones, and everyone is speculating about who will end up on the Iron Throne, and who will die along the way.

And while it may be true that not “all men must die” (as the phrase Valar morghulis translates to from the book’s invented High Valyrian) early, untimely and violent deaths, and, indeed, though there are scattered old characters on the show, both nobles and poor longsuffering peasants, one imagines that it was rare to live to old age in both this fictional version of a medieval world, and in the actual past of the Middle Ages.

What’s more, I suspect that most of us, knowing the life expectancy of even a century ago was so much lower than in our modern times, imagine that “retirement” and “retirement planning” simply didn’t exist until the twentieth century.  In the Middle Ages (and in Europe specifically, since the markers of the Middle Ages weren’t relevant elsewhere), life expectancy at birth was on the order of 33 years old (see Our World In Data for more premodern life expectancy data) –which certainly suggests that no one lived to what we now consider “retirement age”!  Like the men of the Night’s Watch, you work (or battle) until you die.

But if fictional Westeros were like medieval or early modern Europe, it was actually the deaths of infants and children which was the greatest contributor to low life expectancy, and improved treatment of childhood diseases and better understanding of public health (that is, the provision of clean water) which brought about the greatest degree of increase in life expectancy.  For individuals who made it past childhood, it would not have been unusual to live to something close to what we think of as “old age,” an age, which according to Barbara Hanawalt’s The Ties That Bound, a study of family life among medieval English peasants (1986), was perceived of as being about age 60 (p. 228).  Hanawalt cites estimates that a not-inconsiderable portion of the population reached that age; while there are no census records, she reports,

Late sixteenth- and seventeenth-century parish registers show that roughly 8 to 16 percent of the population was over sixty.  And in fourteenth- and fifteenth-century Tuscany 6 to 15 percent of the rural population was over sixty.

What’s more, in Europe, the nuclear family was not just a modern invention but stretches much further back, which meant both that young couples waited until comparatively later ages to marry, in order to be independent financially, and that older couples did not simply expect their children to provide for them as would have been the case in other cultures where all generations lived together in a single living quarters/family compound in which elders were cared for.  As a result, those who reached old age needed some sort of retirement provision rather than simply taking it for granted that they would be cared for by the next generation.

So how did people live once they were too old to continue to work?  For the poor, there aren’t always historical records to tell us, but there are, at any rate, two interesting parallels between retirement in the Middle Ages and our own times, as some oldsters used the equity in their homes to finance their retirement and others purchased annuities.  Of course, these are modern ways of expressing medieval approaches, but they still describe what occurred.

What I’ve labelled “using the equity in their homes” is what Hanawalt calls the “retirement contract,” an agreement between the aging peasant or peasant-couple and a child, other relative, or wholly unrelated person looking to get started in life.  Hanawalt writes,

these contracts provided that the retiring peasant would relinquish the use of his buildings and lands in exchange for food, shelter, and clothing from the person, whether a kinsman or not, who took up the contract.

Some instances of such contracts in the records describe the precise amounts of food and clothing to be provided.  Additions to houses might also be built in which the newly-“retired” couple would live, or the medieval equivalent of a “granny flat,” though sometimes they would be relegated to climbing a ladder to an attic or loft.  Of course, more well-to-do peasants could bargain for better provisions, and small landowners, or cottars, would be obliged to promise that

all of their household equipment, clothing, and other movables would go to the person who agreed to provide for them in their old age.

One might also guess that a young person would expect a lower “price” for supporting a poor cottar by undertaking a retirement contract only under circumstances in which that individual was relatively more infirm (and closer to death) than in the case of a better-off peasant landholder.

If the retirement contract was the equivalent of using home (farm) equity, then the “annuity” had its analogue in the purchase of a spot in a hospital.  The concept of a “hospital” at the time was far broader than now, and encompassed not just institutions to care for the sick but also institutions that evolved into almshouses/poorhouses (before these institutions disappeared) and “bedehouses” (in which residents were expected to pray daily for the benefactor), which  cared for the poor and/or served as a retirement home for those who could afford to pay, yes, an Entrance Fee, which would guarantee room, board, and the necessities of life, for one’s life.  The BBC website HistoryExtra explains

The going rate varied over time, between and within hospitals, but at St John’s Hospital in Sandwich most new brothers and sisters paid 6s 8d. (A Margery Warner paid with 1,000 tiles, perhaps floor tiles), whereas at neighbouring St Bartholomew’s the fee to remain at the hospital for the remainder of the inmate’s life might be as high as £19 (the equivalent of around £8,500 today). Although this sounds expensive the new brother or sister might pay in installments and live for several decades at the hospital, expecting in return to receive board and lodging, clothing, shoes, fuel and other necessities, without further payment.

The website Pensionados of the Past, written by the Dutch scholar Jaco Zuijderduijn, provides instances of hospital-retirement homes in the Netherlands.  In one instance, documents from 1573 describe a woman’s woes when certain documents, ruined by water damage, turned out to be financial instruments intended to finance her pending retirement at a hospital in Leiden.  Separately, the author describes a case in Amsterdam:

That living conditions in medieval retirement castles were not always very rosy was also discovered by the woman Katrijn Hilbrant. She retired into Saint Peter’s hospital in 1482, paying the entry fee this required. In 1485 she paid another seven guilders – equivalent to a month’s wages – to be relieved from labour duties. In her own words, she ‘only wanted to sew, weave and spin if she felt like this’.

 Apparently Katrijn did not mind to do textile work once in a while, but not so often as the labour regime in Saint Peter’s hospital prescribed. Based on her account it seems that some of the elderly women were put to work in the hospital’s sweat shop, producing textile that earned the institution some money. Apparently the only way to prevent spending one’s final years in hard labour, and to retire altogether, was simply to pay up.

Of course, besides these “respectable” means of support in retirement, there were plenty of poor elderly who were dependent on charity in villages and cities, and still more who we can assume were supported by their children without any records documenting the fact, but my point is this:  retirement planning is not a new endeavor brought about by a lengthened and even unnatural life span in excess of a normal working age.  The particulars of retirement planning in 2019 are different than they were in 1219, but it is an age-old, not a brand-new concern.

 

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary General Interest

What, actually, is a “fair tax”?

Not the Pritzker proposal for an Illinois tax hike, despite his and his supporters’ claims, actually.

After all, we intuitively know what’s fair and what’s not.  Rules which, in theory and in practice, treat everyone evenhandedly are fair.  Rules which are arbitrary, or penalize or advantage some people or groups over others, other than for appropriate reasons, are unfair, and all the more so when they are set by a minority without a democratic process (or subverting/manipulating a nominally-democratic process).

The pop tax?  Intuitively, it was clear that it was unfair.  One group of people (pop-drinkers) was asked to pay a disproportionate share of the county’s taxes, and within that group, some were burdened more than others — those without cars, without storage space, too far towards the center of the county, or otherwise less able to drive elsewhere to get their pop.  (Yes, at the time my husband worked in Lake County and until the tax was rescinded he bought the Family Pop Supply on his way home from work.  And, yes, if the tax was applied nationwide this specific complaint would be mitigated, but not that of the unfair targeting of pop-drinkers.)

Or consider the gas tax:  people are reasonably OK with it if it actually funds road repair.  But tell them that the gas tax is being used for entirely unrelated purposes that are nominally transportation-related (Cato reports that Kansas, Maryland, New Jersey, Minnesota, Connecticut, Texas, and Rhode Island each divert over 50% of these taxes in some fashion or another) and taxpayers are less happy.

So what of the Pritzker tax proposal?  (For a refresher on the particulars, see my prior article; the latest update on its status comes from today’s Tribune, which reports that the State Senate’s Executive Committee voted along party-lines to approve placing the tax-enabling amendment on the 2020 ballot.)  This proposal is being marketed as a “fair tax” to such a degree that the original language of the proposed amendment even used this phrasing.  It was cringeworthy:

There may be one tax on the income of individuals and corporations. This may be a fair tax where lower rates apply to lower income levels and higher rates apply to higher income levels.

(Thankfully, the proposal was amended to remove both the current constitution’s restriction on graduated income taxes and this new language about a “fair tax.”)

To begin with, there is nothing intrinsically fairer about a graduated income tax than a flat tax.

What’s more, specific elements in the tax as proposed tend to move it to the “unfair” category.  The lack of separate brackets for singles vs. married couples mean that a married couple at a certain income level will end up paying more in taxes than if they had not married.  The “millionaire’s tax” that applies for one’s entire income rather than at the margin means that anyone earning $1,000,001 will pay a patently unfair penalty for that last dollar in income.  (Comically, the original childish language about the “fair tax” would have prohibited this anyway.)  The very fact that the brackets are structured with a dramatic jump in rates, and with a nominal tax cut for moderate earners means that it is being promoted to voters not as the most appropriate way to solve Illinois’ perpetual finance woes, all things considered, but as a way to get something for nothing:  “you get all the state spending you want while we ensure that only a tiny minority of people will have to pay.”

I should add that I am increasingly having misgivings about the labelling of this sort of tax as “progressive” and the inevitable pairing with other types of taxes for which lower-income folk pay relatively more, as a share of their income, as “regressive,” because it is becoming clear that these are not descriptive, but are their own forms of value judgements.  And, while it might, generally speaking, for taxes to fall disproportionately on those who can better afford to bear their burden, tax terminology should be descriptive, not loaded.

On the other hand, strictly speaking, it might not even be accurate to call the Pritzker proposal a “graduated” tax at all.  There are functionally only two brackets, “somewhat less than 5%” and “somewhat less than 8%”, so that there isn’t anything gradual about it.  But, yes, that’s a nit-pick.

And practically speaking, I don’t know where the proposal is headed.  Certainly it’s not being rubber-stamped, or if it is headed toward such, the process is, at any rate, taking longer than for, say, the minimum wage hike, though it may be that this is just a matter of the lack of urgency (regardless of how quickly or slowly the bill passes, the election at which the amendment would be voted on would take place in 2020) rather than lack of votes.  Strategically, on the one hand, it seems a mistake to have a specific proposal rather than saying, “the Illinois constitution wrongly handicaps the state in making its determination of the best type of taxation at any given point in time.”  Yet the fact that our state government is so perpetually untrustworthy meant that, practically speaking, no voter in their right minds would accept a plea of “trust me.”

What’s the alternative?  Obviously, I’m in favor of a pension-related amendment, and pairing the two would have better enabled politicians to make the claim that these amendments are about long-term good governance rather than short-term coffer-filling.  The Tribune went a step further in an editorial today:

Today, a new world: Pritzker would “Let the people vote.”

So how about a package deal, Governor, of amendments or statutory changes: Let the people vote not just on taking more billions of dollars a year from wallets — an amount sure to grow and grow as tax rates rise and rise. Let the people also vote on rewriting the rigid pension clause of the constitution. Let the people vote on term limits. Let the people vote on creating a fair remap scheme.

The pension clause, manipulated by lawmakers eager to reward their cronies in public employee unions, has created much of the financial misery that confronts Pritzker. Lack of term limits has entrenched many of these same lawmakers. And the current remap scheme assures their re-election in perpetuity.

So we’re all agreed, Governor? Taxes, pension reform, term limits, a fair remap scheme. “Let the people vote.”

Sounds good to me!

 

Image: https://media.defense.gov/2019/Feb/12/2002088973/-1/-1/0/181206-A-UM169-0001.JPG; https://www.dover.af.mil/News/Article/1755127/what-you-should-know-about-filing-2018-taxes/ (public domain/US gov)

Jane the Actuary General Interest

Not every disparity is discrimination, car insurance edition

Here’s a Pew report from back in February that I recently came across:  “What? Women Pay More Than Men for Auto Insurance? (Yup.)”  Here are some of the key bits:

It’s a widespread belief that men pay more for automobile insurance than women. But that’s only true for young adults.

Several studies in 2018 and 2017 revealed that women over 25, particularly those between 40 and 60, often pay more than men — not less — for auto insurance, all other rating criteria being equal. . . .

In an interview, [former California Insurance Commissioner Dave] Jones said it’s fair for insurance companies to set premiums based on a driver’s accident history, number of speeding tickets and other factors that are under the driver’s control. But using gender is unfair because a person has no control over that, he said.

What’s going on?  The report indicates that there was no seeming consistency across insurers.  It cites a 2017 Consumer Federation of America study, in which, among 60 year olds, differentials ranged from a premiums 4% higher for men at Liberty Mutual to a 12% higher for women at Geico.  For 40 year olds, the differences among 6 insurers studied were -1%, 0%, 5%, 8% and 16% higher premiums for women.  And, oddly, for 20 year olds, premiums were higher for men, ranging from a 5% to a 16% difference, except at Geico, again, where women had 6% higher premiums.

Is this discrimination?  Are women being charged more than men, for no particular reason except that rate-setters want to give advantages to men because of the patriarchy?  The Pew article suggests, in the midst of a broader discussion around rate-setting processes, that there’s something nefarious going on:

But a professor at University of Minnesota Law School, Daniel Schwarcz, said if companies are not allowed to use “outdated stereotypes based on generalities” about men and women, the insurers will have to consider “more directly” such measures as the actual number of miles driven, the number of years customers have been driving and where they live.

Really?  A lawyer is asserting that actuaries develop rate models which add in some sort of factor based on the “women are bad drivers” stereotype their fathers or grandfathers might have believed, and that’s worth referencing in an article put forth by an organization as respected as Pew?

It should go without saying that actuaries price insurance premiums based on the totality of the data available to them.  Price a rate too high for a given rate class (age, sex, residence, driving history, etc.) and you lose a sale.  Price a rate too low and you lose money on that sale.  Especially now when customers are able to comparison-shop far more easily, insurance companies’ actuarial departments want to get this right.  At the same time, I suppose, if a company has identified a demographic which it believes to be particularly susceptible to marketing and less likely to comparison-shop, they might focus more on marketing to that group and worry less about the competitiveness of their prices.  (Heck, are women less likely to comparison-shop insurance and more likely to choose a brand that gives them warm fuzzies?)  And all of the above is true even with the disparities in pricing among various insurers, simply because each of them will have different pricing models, and will have different claims experience even for the same demographic group (and an objectively similar demographic group could differ if different insurance companies attract different types of customers) — complexities of business operations which these companies are under no obligation to disclose to the general public any more than KFC must provide its secret recipe.

But the 2017 Consumer Federation of America study the Pew study references takes its claims even further, writing

The inconsistent pricing decisions of these insurance companies illustrates CFA’s concern that tying auto insurance rates to factors that a customer cannot control and have nothing to do with their driving safety record – such as one’s biological sex – leads to unfair discrimination and indefensible claims of actuarial soundness. . . .

“Every state but New Hampshire requires drivers, regardless of their sex, to buy auto insurance, so regulators and lawmakers have a special obligation to make sure coverage is priced fairly,” said CFA insurance consultant Douglas Heller, who conducted the study . . . . “What we have found is that insurance companies punish female drivers with perfect records more often than men, and far more often than we expected. We also found that the insurance companies’ use of sex as a rating factor does not seem to reveal much in the way of a consistent risk assessment, and regulators should reconsider allowing companies to continue using it at all.”

But let’s back up:  should insurance rates be only about those characteristics which customers can “control” — in this case, driving history and maybe residence?  Based on this rationale, there shouldn’t be any differentiation by age, either, but no one suggests that 16 year olds and 36 year olds should have the same rates, because it is generally acknowledged that teens, as new drivers, are less skilled, even though these are both items that cannot be “controlled.”  (And, quite honestly, I find it believable that men, once they outgrow their impulsive years, might be more likely to be better drivers; in terms of external factors, women might be more likely to be distracted by kids they’re transporting somewhere, and, besides, it is not out of the question that men could have a better awareness of their environment, spatial awareness, following distance, reaction time, whatever, in the way that there are simply differences between men and women.)

What if a state mandated that, since it’s unfair to charge young adults more for insurance when they can’t “help it” that they’re inexperienced drivers, insurers couldn’t differentiate but had to wait until a driver got into an accident or got a ticket?  (Yes, I know, exactly the demographic with the most political power would be disadvantaging itself, so it’s purely hypothetical.)  Would it be fair to say that any subsidies young people receive would be evened out by paying relatively more than otherwise when they get older?  After all, they’ll earn more then, too, on average.

But intuitively we know this is not actually fair. It is true that all drivers are required to have basic levels of insurance, but there is discretion in terms of the deductible amount and whether, in addition to state minimums, one elects collision/comprehensive insurance.  Plus, of course, drivers purchase the cars they do in part knowing that insurance premiums vary among cars (due to the age and cost of the car plus relative repair expenses and risks of theft).  What happens if these optional coverages become subsidized for some groups?

Now, that being said, it would genuinely be interesting to see what’s driving the rate disparities (no pun intended).  But suggesting directly or indirectly that insurance companies are anti-woman isn’t helpful.

 

Image: https://pixabay.com/photos/traffic-highway-car-driving-road-966701/

Jane the Actuary Retirement

Forbes post, “Pay Off Debt Or Save For Retirement? It’s Time For An Actuary-Splainer”

Originally published at Forbes.com on March 25, 2019.

 

Turns out, this is really a two-part question.

First, if you’re an individual trying to decide how to manage your finances, what’s the best approach?

And, second, if you fancy yourself a policy expert, should you promote a mandatory-savings program like Australia’s, give people options, or step back entirely?

The very short answer to the first question is this:  pay off high-interest-rate debt first.

Which begs the question:  when does the interest rate count as “high”?  Most of the time, that’s when the rate is higher than the investment return you can reasonably expect from your IRA or 401(k).  If you’re paying 15% interest on a credit card (at the low end according to the website ValuePenguin), and you expect to earn 6% in your IRA, this is obvious:  pay off the credit card debt first.  If you have a home mortgage with an interest rate of 5%, don’t be in a rush to pay it off early at the expense of retirement savings.  There is a grey area, though:  if you have an employer match on your contributions, don’t think of that as “free money.”  Think of it as boosting the interest rate that you earn over time — for example, a pure dollar-for-dollar match might be similar to the effect of doubling the investment return* — so that retirement savings can come out as the “winner” in your comparison.  At the same time, if you expect to gain from the tax advantages of an IRA or 401(k), that’s worth some extra interest in the comparison calculation.

(*This isn’t literally true, and the math is a lot more complicated but the point is that it might not always be a sure thing to go for the match at a cost to continued interest-rate compounding on your debt.)

This seems obvious, no?  But here’s a claim from the National Employment Law Project that caught my attention over the weekend:  in light of a paper voicing skepticism of state-run auto-IRA plans because they “could hurt low-income participants because they will be investing in lower-return retirement plans instead of paying off high-interest shorter-term revolving debt, such as credit card debt,” the author, Michele Evermore, responded,

these findings do not make a persuasive case for limiting access to savings vehicles for low-income workers. That’s because the multiplier effects of starting to save for retirement while young are hugely beneficial for the majority of workers.

The error Evermore makes, of course, is that of thinking of retirement savings and debt as two entirely separate buckets, and promoting the beneficial effect of compound interest in the former while ignoring its pernicious effect in the latter case.

Here’s an example:

Imagine you find yourself at age 25 with a desire to save for retirement but also with $10,000 in credit card debt.  You’ve done your budgeting and have $3,000 per year that you can apply to paying off that debt or saving.  If you apply all of that to savings and earn 6% in investment earnings over time, then you can end up with $17,000 five years later, and that will continue to increase over time.  But if you never make payments on your debt, and have a 15% interest rate, you will owe $20,000, and have a -$3,000 net worth.  If you pay off your debt instead, you will have a $0 net worth, which isn’t great but is in fact more than -$3,000.

What if you have an employer match which doubles your contribution, so that a $3,000 contribution to savings is worth $6,000?  In the short-term, that boost gives you a positive net worth very quickly, but the debt’s interest rate will compound enough to outpace the investment returns, particularly if that savings rate doesn’t grow over time.  So, yes, contribute at least enough to receive the full match, but not at the expense of paying down your debt at least to the degree to keep the interest rate compounding at bay.

The bottom line:  compounding investment returns are great.  Compounding debt interest can be ruinous.

So what does this have to do with auto-IRAs or mandatory savings?  Experts worry that forcing people to save, like Australia does, or creating strong nudges that have a similar effect, will just send more low-income workers into debt, and economics researchers have been trying to find out what happens in the real world.

There does appear to be some good news, in the form of a study, “Borrowing to Save? The Impact of Automatic Enrollment on Debt,” by a team of Harvard researchers (thanks to Scott Graves for the link via twitter @SHGraves29), which examines the outcomes of a “natural experiment” when the U.S. Army began auto-enrolling its civilian new hires into the Thrift Savings Program with a rate of 3%, and found that among those enrollees, “bad debt” did not increase but car loan and home mortgage balances did.  Is this good news, because car and home loans have low interest rates in any case?  Or, to the contrary, does this indicate that new enrollees previously had been able to fund car purchases, and make greater down payments, out of nonretirement savings which no longer exists? — But, on the other hand, if the autoenrollment program had been harming people by taking away money that was otherwise going to emergency funds, then presumably researchers would have found higher levels of credit card debt as participants resorted to paying repair bills with credit card debt.

It’s all a muddle, and relies heavily on Americans being able to navigate through combining retirement savings with their other financial needs.  That’s one of the reasons that in at least some countries with mandatory or auto-savings, the lowest tranche of income is excluded entirely (see “Should Poor People Save For Retirement?“) with their income needs in retirement taken care of with a flat anti-poverty-focused Social Security benefit.  In the United States, on the other hand, we’ve got a Social Security formula that is weighted towards low income but leaves people likely to struggle with determining how it fits in with their actual circumstances and savings needs.  In a perfect world, auto-IRA programs such as OregonSaves and equivalent programs coming online in Illinois and California would provide meaningful counsel to participants to help them identify whether and how much they should save, given their income level and other circumstances, but they fall short, and, realistically, given the Social Security formula, it’s difficult to prescribe a simple rule of thumb.

And here’s one final wrinkle to consider:  in an extreme case of a person with high levels of personal, unsecured debt, and a high IRA account balance, that balances is protected against creditors in the case of a bankruptcy.  Had that individual chosen, over the course of a lifetime, to pay off debt but never been able to save, she would have no recourse to go back to creditors and say, “please give me my money back so I can afford to retire.”

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “So, Hey, Is Australia An Example To Follow For Mandating Employer Retirement Benefits?”

Originally published at Forbes.com on March 20, 2019.

 

They are never-ending, it seems:  proposals to create a form of nationwide mandatory retirement savings.  A recent article at Third Way lists some of the newer ones, and proposes its own.  Forbes contributor Teresa Ghilarducci has been promoting what she has alternately been calling Guaranteed Retirement Accounts or the Retirement Savings Plan.  I have my own pet solution with mandatory retirement savings as an integrated part of a Social Security reform.  Some of these proposals require employees to contribute their own earnings, others require employer contributions, and yet others require both.

And, as it happens, any such program would not have to start from scratch.  It would not be innovative or especially unusual — if you take an international perspective.  A year ago, I profiled the retirement system in the United Kingdom.  Hong Kong and a number of Asian countries have what they call “provident funds.”  And Australia has a system they call Superannuation, in which all employers are required to contribute 9.5% of an employee’s pay into a retirement fund.

Now, there’s a lot to say about this system and other systems outside the United States but I want to focus in this article on one specific issue:  how did they get from here to there?  9.5% of income is a lot, and that contribution rate has to be understood in the context of an overall state pension system that’s much different than ours.  But there is one element of their experience that I think is very useful to consider:  what happens when a mandatory contribution (for retirement savings, or a new payroll tax for maternity leave, or something else) appears out of nowhere?

One gets the impression that many supporters of new taxes, especially when directly employer-paid, believe that employers have a secret stash of money somewhere that they’ll be persuaded to cough up, or that they’ll cut executive pay as needed.  The wiser, but more trivial answer to any such tax hike is “it all ultimately comes out of worker pay.”

And in the case of Australia more specifically, worker pay increases were effectively directed into Superannuation contributions, with a slow phase in starting at 3% in the program’s first year and increasing one percentage point every other year to 9% in 2002.  The further increase to 9.5% likewise happened in two steps, to 9.25% in 2014 and 9.5% in 2015.

But even this didn’t come from nowhere; Australia’s larger companies had long offered retirement savings programs to their workers, but only on a limited basis.  At the same time, unions played a much more significant role in the Australian economy, and negotiated wages not just for one employer at a time but for entire sectors.  In 1986, a time of relatively high inflation, the Australian government orchestrated an agreement for a wage increase of 6% for those covered by these wage agreements, with the stipulation that half of that increase would take the form of a 3% retirement savings contribution.  (See “Mandatory Retirement Saving in Australia” by Hazel Bateman and John Piggott for a history of the system.)

To ensure access to Superannuation contributions even for those employees outside the union wage agreement system, the government mandated contributions for all employees in 1992.  Here’s an account of the politics behind the change:

‘Wages were due to go up 3 per cent that year and he ([Prime Minister] Paul Keating) wanted to restrain inflation,’ [economics reporter] Mr [Peter] Martin says. ‘Of course he still wanted to give workers the wage rise, so he and Bill Kelty, the head of the Australian Council of Trade Unions, came to a deal that employers will have to give the workers 3 per cent, they just won’t be able to spend it. And so that was the deal, that all awards had to give employees 3 per cent of their salary paid not as salary but into superannuation funds.’

And again, it was acknowledged that the mandated superannuation contributions were not coming out of employers’ pockets but were a redirecting of employee wage increases; so long as those pay increases exceed inflation, workers are no worse off in terms of living standards but accumulate retirement savings they otherwise might not have.   Another article, from Australian-based The Conversation, reports that recent renewed discussions around further increases in the contribution rate up to as high as 15% are based on the belief by supporters that employers are unfairly withholding wage increases, so that mandated increases in Super contributions are a way to force employers to grant this increase — though the author, Brendan Coates, disputes this, since, so long as nominal wages grow due to inflation, employers can implement Super contribution increases out of this nominal pay increase without having to cut pay.

In this respect, what Australia did as a country is not all that different from the savings strategy being promoted for American workers, who are encouraged, when they receive a raise, to use that money to increase their savings rather than just boost their spending.  It’s the same principle that underlies the concept of “auto-escalation” in 401(k) accounts, when employers design the accounts so that, having first automatically enrolled their employees at a certain contribution rate when they are hired, the amounts those employees contribute increase each year at the same time as that year’s raises are processed, so that employees increase their savings without seeing a reduction in their take-home pay.  (See this description at US News.)

The bottom line is this:  if American workers’ wages rise above inflation, then mandating that some of that increase be directed to retirement savings might well be a pain-free way to achieve a long-held goal.  But that’s not a sure thing.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Public Pensions And Social Trust”

Originally published at Forbes.com on March 17, 2019.

 

So it seems that I hit the one-year mark of my writing on retirement at this platform, and have still not managed to address some of the topics I wanted to discuss, in particular, questions of what pensions look like abroad and what we can learn from them.  But right now I find myself thinking about international comparisons in another way, around the question of social trust.

Round about a year ago, Megan McArdle, formerly a Bloomberg columnist and now writing at the Washington Post, wrote a series of articles coming out of a visit to Denmark.  Her first, at Bloomberg (paywalled), expresses the gist of the article in its title, “You Can’t Have Denmark Without Danes; What a small, happy country can teach a huge and fractious one. And what it can’t.”  Fundamentally, Demark can do what it does and function as well as it does because of its considerable degree of social cohesion; a sense of cohesion that, to her understanding, was not the result of an expansive welfare state but a precondition for its success.  (She subsequently expanded on this in a series of tweets, though non-subscribers will miss out on what I vaguely recall, from pre-paywall days, to have been an anecdote about losing her wallet and having it returned.)

She subsequently wrote again on the topic of the Danes’ system of disability and the country’s level of social trust at the Washington Post, observing that it has very generous social insurance provision of such benefits as disability income replacement with neither the sort of cheating nor the fears of cheating that you’d see elsewhere, including, yes, the United States, where one periodically sees reports of city workers taking advantage of generous disability pay-replacement and being seen out and about engaging in all manner of activities that indicate their claims of incapacity are fraudulent.

“Social trust” is, well, what it sounds like: How much do you trust your neighbors? And in turn, how trustworthy are they? In a low-trust place such as Greece, people don’t trust their neighbors not to cheat, which in turn makes them more likely to cheat themselves, because why should you stay honest when everyone else is getting away with something? This affects everything: whether people pay their taxes, whether they take benefits they don’t really need, how easy it is to regulate companies. And social trust also works as a productivity booster, because you can do away with a lot of the cumbersome monitoring that is ubiquitous in modern societies — the supervisors who oversee low-level workers, the store clerks who keep an eye on the customers. Every worker who is not making sure that people don’t steal or shirk can be re-employed doing something that actually increases output.

The United States simply doesn’t have that level of trust. And while it would be nice to think that we could get there if companies and government simply stopped acting so suspicious, the fact is that they frequently act suspicious because, well, Americans cheat more than Danes do. (Compare, for example, the American and Danish rates of tax evasion). Moreover, the mutual suspicion that Americans feel for each other restricts the range of politically feasible policies. Even if people aren’t cheating on benefits, if there is a widespread social belief that your fellow citizens might, you will not be willing to support a generous welfare state. (This helps explain why support is highest for old-age benefits in the United States; it’s hard to fake turning 65).

I find myself revisiting this article in light of both my own articles on prospects for public pension reform in Illinois (among others, my own proposal for reform and  my pessimism that Illinois politicians even recognize the importance of pension funding in the first place) and models for improved systems such as Wisconsin’s (and — spoiler alert — there are other systems with risk-sharing elements which I’ll profile soon) as well as the politics around Illinois Gov. JB Pritzker’s proposal for a graduated income tax.  In both cases, any such legislation requires amendments to the constitution Illinois adopted in 1970.  And in both cases, Illinois faces a lack of social trust.

Does a statement about public employee pensions belong in the constitution?  As it turns out, Illinois is only one of two states (the other is New York) with an explicit guarantee protecting future accruals.  (Others guarantee this by means of state supreme court decisions.)  Does it make sense to prohibit a graduated form to an income tax in a state constitution? Illinois, Michigan, and Massachusetts are the only ones which do so.   (North Carolina passed an amendment capping income tax rates to 7% in November 2018; in a peculiar turn of events, this was overturned in a February court decision because of the claim by plaintiffs that the state legislature was invalidly gerrymandered.  The decision is being appealed.)

As the Chicago Tribune reported in 2013, no thought was given in the 1970 discussions to the question of funding those pensions:

In short, state and local governments would be required to keep their pension promises but not be required to sock away enough money to cover payments years into the future. When it came to funding, officials of both parties in Illinois took significant advantage of the escape clause, helping them skate by for decades without having to make politically difficult decisions on raising revenues or cutting services to meet pension obligations.

In May 1971, just weeks before the new constitution would go in effect, an official state pension oversight panel of lawmakers and laymen issued a report warning that the new pension safeguards were a mistake.

The Illinois Public Employees Pension Laws Commission, which no longer exists, said it had opposed the language inserted into the constitution and had asked one of the sponsors to soften it or at least read a statement into the convention record that it wouldn’t preclude “a reserved legislative power” to change benefits in order to keep retirement plans sound.

Nothing came of the request, the report noted.

As it happens, I’m on record in support of removing both these clauses from the Illinois constitution in one fell swoop.

But to raise the issue of a change to the constitution in either of these respects raises fears:  how can we trust the legislature to use their newly-expanded powers reasonably, sensibly, justly?  Republicans will cut the pensions of hapless retirees!  Democrats will recklessly raise taxes!  In comments at my personal website JaneTheActuary.com and via Twitter @JanetheActuary, readers told me that they simply could not believe that Illinois politicians would make the hard political decisions needed to reform pensions, when it would cost them votes and would cost them campaign funds.  And similarly with respect to the proposed income tax amendment, opponents raise objections that this is just Pritzker’s opening bid, but that, once the limits on graduated income taxation are removed, the Democratic supermajority will be unfettered in its tax-and-spending spree.

It is, in the end, the fruit of a long history of corruption in Chicago/Chicagoland and Illinois.  After all, just this past February, the Chicago area was named the most corrupt in the nation, based on its share of corruption convictions.  Statewide, Illinoisians can now breathe a sigh of relief that our past two governors appear not to have been criminals, unlike their two predecessors.  Reforming pensions and instituting risk-sharing mechanisms simply can’t happen if Illinois voters don’t trust that their politicians will seek to make fair decisions.

 

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.