Source document: https://docs-lawep.s3.us-east-2.amazonaws.com/1697803907758.pdf (Ireland)
Submission to Joint Committee on Social Protection, Community and Rural Development and the Islands In relation to General Scheme of the Automatic Enrolment Retirement Savings System Bill Submission by Colm Fagan, November 2022 Introduction This submission proposes an alternative design for the default fund (Head 33 of the Bill1), which delivers more than 50% better value to members than that proposed in the current draft.
The better value means that required maximum contribution rates from employees and employers fall from the 6% stated in Head 9 of the Bill to 3.9%, with a corresponding reduction in the State’s maximum contribution from 2% to 1.3%.

The proposed alternative design for the default fund means that the scheme will be easier and cheaper to administer, which in turn will mean lower costs and charges (Head 64) and faster implementation.
Furthermore, the default fund design proposed in this submission makes Head 34 (Alternative funds) superfluous.

Members will be able to take a regular income from the scheme in retirement under Head 59 (Retirement Products).

Bizarrely, Head 59 as currently drafted does not include any provision for members to take a pension from the auto-enrolment pension scheme.

My record of achievement shows that my proposal merits serious consideration.
In October 2022, I was awarded joint first place in an international competition organised by the UK Institute and Faculty of Actuaries, the brief for which was “to deliver a low-cost affordable pension to the majority of the population”.

My paper was titled “A New Approach to Auto-Enrolled Pensions”.

The paper, and a 1½ page summary, can be found here.

An earlier version, which I presented to the Society of Actuaries in Ireland in January 2021, can be found here.
My alternative design of the Default Fund is described in lay person’s language in a recent article in “The Currency” magazine here.

Appendix 1 sets out my career highlights.

It shows academic and business success, and recognition by peers, including my election as President of the Society of Actuaries in Ireland.
Head 33: The Default Fund All default funds are trying to find a balance for members between risk and return: the higher the desired return, the greater the risks that must be taken to achieve it.

For the purpose of this paper, investments are considered as either (a) high risk, called “equities” for short, or (b) low risk, called “bonds” for short.

Historically, long-term investment returns on equities have exceeded those on bonds by a considerable margin.

The same is expected to hold true in future.


This paper assumes that returns on equities will exceed those on bonds by 4% a year on average, an estimate that probably errs on the conservative side.2 An average return on equities of 4% per annum more than on bonds means that the value after 20 years of an investment in equities, with dividends reinvested, will be more than double that of a corresponding investment in bonds, also with dividends (coupons) reinvested.
1 The Automatic Enrolment Retirement Savings Systems Bill 2022 2 A survey, quoted in https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3861152 shows an average expected future equity risk premium for the US (1,756 respondents) of 5.5%, with a range from 3.1% to 8%.

1 In the short-term, however, values of equities can fall sharply.

For example, in 2020, they fell by 20% in the first three weeks of March as concerns mounted over the impact of COVID-19.
A worker whose funds were invested entirely in equities and who was due to retire in the third week of March 2020 would have seen a fund worth €100,000 at the start of March fall in value to €80,000 by the time they retired.

The Conventional Approach to Default Funds Conventionally, automatic enrolment default funds address the risk versus return challenge by investing a high proportion of younger members’ funds in equities, with the proportion falling as members age.
For example, a 30-year-old’s fund might be invested 100% in equities, with the equity proportion falling to 75% for a 50-year-old and to 50% for a 60-year-old.

(These percentages are purely illustrative - different asset managers take different approaches to reducing the equity proportion as members age.)
An approach on these lines is implied by the wording of sub-head (2) (d) of Head 33 – “the default fund will take into account the age profile of participants within its risk parameters” - and by the reference in the accompanying explanatory note to “restricting the risk of significant losses and strong fluctuations in the individuals’ pension savings close to retirement”.

A default investment strategy on the lines proposed in the Bill will require a large number of sub- funds.
The main auto-enrolment scheme in the UK3 has 46 default funds, one for each future retirement age.

Ireland will require a similar number, to cater for different asset mixes at different ages, if the Oireachtas opts for the current draft of Head 33.

The biggest problem with this approach is that it means taking the foot off the gas when members’ funds have their maximum earning power.
The investment return in a single year for a long-standing 64-year-old contributor could exceed the total return in the first ten years for a young contributor.

By shifting funds from equities to bonds as contributors age – and as their pension pots get bigger - investment managers are depriving older workers of the opportunity to earn those higher returns.
Alternative Proposal for Default Fund under Head 33 My proposed design for the default fund allows all contributors – old and young – to enjoy equity returns for their entire careers, while avoiding the risk of sharp falls in adverse market conditions, such as those that prevailed in March 2020.

It achieves this by stipulating that all member transactions with the fund take place at values which smooth out market fluctuations.

The graph below shows pictorially how smoothing works.
The steady progression of smoothed values (blue line) contrasts with the jagged changes in market values (orange line).

The graph shows smoothed values never falling, in contrast to market values, which fall sharply on occasion.
3 That run by NEST (National Employment Savings Trust) 2 Looking again at the earlier example of a worker with a fund worth €100,000 at the start of March 2020, the smoothed value would probably have increased slightly during the month, and the member would have avoided the sharp fall to €80,000, as would have been the case if they were obliged to sell at market value on retirement4.
The details of how this is achieved in a manner that is fair to all is set out in the paper to the Institute and Faculty of Actuaries referenced above.

The smoothed approach to the default fund under Head 33 means that account values will progress smoothly from month to month, quarter to quarter, year to year.

The progression is so smooth that workers’ pension accounts can be administered like high-interest deposit accounts.
The average interest rate will be around 4% a year more than members could earn by having their money on deposit.

The implications of this are explored in the discussion of Head 64 below.
Head 34: Design of the Alternative Funds Head 34 states that the CPA shall offer three other funds, in addition to the Default Fund of Head 33, to accommodate workers with different risk appetites: (1) a low-risk fund, which will offer the prospect of low returns for workers with low risk appetites; (2) a high-risk fund which will offer the possibility of high returns, but at high risk, for workers with high risk appetites; and (3) a medium- risk fund for workers who want something in between.
If the Oireachtas opts for the Default Fund approach set out in this paper, there will be no need for the alternative funds, since the Default Fund will offer all members the ideal combination of high expected returns at low risk, irrespective of individual risk appetites.

It will mean that Head 34 can be removed entirely and with it will disappear the need for the complex systems required to administer and manage the alternative funds.
Also, an advisory service will be required under Head 34 as currently drafted, to counsel workers at date of joining and at various points throughout their careers on the merits of different fund options.

Under the proposal in this paper, the need for such an advisory service will disappear, as will the cost of providing it.

That will result in significant savings, as good advice does not come cheap.
Head 58: Provision of a lump sum; and Head 59: Retirement Products Head 58 of the Bill states that all benefits under the scheme will be paid to retiring workers in the form of a lump sum, with no possibility of taking a pension.

Head 59 states that the Minister may introduce regulations at a future date allowing members to draw a pension from the scheme.

The purpose of a pension scheme is to provide pensions.
It is bizarre that a Bill establishing an AE scheme will not allow members to take pensions from it.

Head 59 does state that modifications may be introduced at a future date to allow members to take a pension.

It is as if workers are embarking on a long journey, with the first part being charted out, but no guidance whatsoever being given on the second part of the journey, from retirement to death, a road which includes many hazards and pitfalls.
It is foolish to think that a pension payment facility can be reverse engineered under Head 59 when the scheme is up and running.

It will prove an impossible task.

The position is similar in the UK.

There, some critics claim that lobbying by pension companies, consultants, financial advisers, and other vested interests caused government to drop plans to add a pension payment facility to its auto-enrolment scheme.
The UK government’s decision left private sector players with an open goal when workers’ pension pots mature.

4 It is worth bearing in mind that the smoothed value at the start of March 2020 in this hypothetical example might have been less than the market value of €100,000.
3 Under the approach to the Default Fund proposed in this paper, members will remain in the scheme post-retirement, earning interest at the smoothed rate (expected to equal deposit interest rates plus 4% a year on average) drawing from their accounts for a recurring pension income.

It will take some years for members’ savings under the auto-enrolment scheme to reach significant sums.
Therefore, de minimis provisions should be included, to allow members to withdraw all their benefits in lump sum form if the alternative pension would be trivial.

It is far better to express the lump sum option in this manner, i.e., as an exception to the general requirement to take a pension rather than the opposite, of the pension being an exception to the general requirement to take a lump sum, as is stated in the current draft of Head 58.
Head 9: Contribution Rates Staying in the default fund post-retirement, as proposed in this paper, offers many advantages over the alternative of leaving the scheme and buying a post-retirement product from the private sector, as is proposed in the Bill: (i) (ii) Retired scheme members will continue to enjoy higher (smoothed) returns from equity investment.
Under the model in the Bill, retiring workers, especially those of more limited means, who will account for the vast majority of beneficiaries under the auto- enrolment scheme, will generally be advised to buy low-risk, low-return products.

Under the current draft of the Bill, retiring workers will be obliged to leave the scheme, withdraw their full account, and seek advice on investment options from a pension consultant, broker, or adviser.
The cost of such advice, directly in the form of fees, or indirectly through commission, can take a significant chunk from small pension pots.

Under the approach proposed in this paper, members will stay in the scheme post- retirement and draw an income from it.

They will have no need for investment advice.

(iii) Members staying in the default fund post-retirement will benefit from lower charges for investment management and administration.
Charges for individual contacts (which members would have to buy if forced to leave the scheme on retirement) are much higher than for group contracts.

Head 9 of the Bill estimates that the required contribution rate for an adequate pension is 14% in total - 6% worker, 6% employer, 2% state.

This estimate assumes that retired members will earn the lower investment returns under (i) above and that they will incur the extra advisory/ commission and administrative charges in (ii) and (iii).
Under the approach proposed in this submission, the required contribution for an adequate pension is 9.1% (3.9% employer and worker, 1.3% State).

The lower required contribution is due in large part to members remaining in the scheme post- retirement, earning the higher returns in (i), being spared the advisory costs in (ii), and incurring group rather than individual charges for administration and asset managements in (iii).
Head 64 (Maximum charge to members) and Head 21 (Expenses of the CPA) Head 64 stipulates that charges on members’ auto-enrolment savings accounts will be expressed as a percentage of assets under management and that the Minister will set a limit on what can be charged, without specifying what that limit will be.

In communications with industry, officials have indicated that the charge will not exceed 0.5% of funds under management per annum.
Head 21 states that the scheme cannot remain loss-making, that while it can lose money in the early years (when funds are low and revenues from management charges are also low) and can borrow from the state to meet the excess of costs over revenues in the early years, any borrowings incurred in the early years will have to be repaid eventually (with interest).
4 Long-term projections of revenues accruing to, and costs incurred by, the Central Processing Authority (CPA) under the Bill’s default fund model5 indicate that a management charge closer to 1% per annum, possibly more, will be required if the CPA is to meet its long-term objective of breaking even and servicing the debt incurred in the early years, and eventually repaying it.
Similar projections of revenues and costs for the default fund design proposed in this paper indicate that a management charge of 0.5% per annum will be more than sufficient in the long-term.

The much-improved financial position under the default fund design proposed in this paper is due to a combination of much lower costs and substantially higher revenues, particularly in later years, than those projected under the Bill’s current model for how the scheme will operate.
Lower costs derive from simpler administration.

As noted above, the smoothed default fund can be administered like a high-interest bank account, with the interest rate being calculated once a quarter and everyone getting the same rate.

Asset management will also be much more straightforward, since all the scheme’s funds will be invested in equities.
In contrast, the model for Heads 33 and 34 in the Bill would require more than 40 unit-linked funds (based on the UK model, there would be 46 default funds, plus the three risk-rated funds), each of which must be priced daily, with units being allocated to or deallocated from funds on a daily or weekly basis.
CPA revenues under the approach proposed in this paper will be significantly higher than under the approach envisaged in the Bill, especially in the long-term, since members will remain in the scheme post-retirement, when their account values will be high and revenues from management charges of 0.5% per annum will also be high.

Under the approach envisaged in the Bill, the higher fund margins post-retirement will all accrue to private sector players.
Under the approach proposed in this paper, costs are projected to exceed revenues for the first 15 years or so, but from circa year 16 on revenues from the 0.5% management charge are projected to exceed costs, with the excess being used to repay borrowings (and interest).
Borrowings, plus interest, are projected to have been fully repaid shortly after year 20, at which time the cost of administering the scheme (including that of managing the underlying assets) is projected to equate to approximately 0.3% of assets under management, with the other 0.2% per annum (0.5% charge less 0.3% expenses) being set aside in a buffer account for members’ benefit.
Summary This submission recommends an alternative design for the default fund under Head 33, which delivers more than 50% extra value to members than the design proposed in the Bill.

The approach proposed in this paper also means that there will be no need for the risk-rated funds of Head 34.

The better value means that the maximum contribution rate falls from the 14% specified in Head 9 (6% employer, 6% employee, 2% state) to 9.1% (3.9% employer, 3.9% employee, 1.3% state).
Investment returns credited to members’ pension accounts will be smoothed, so that members will experience low fluctuations in investment returns and accounts can be administered like high- interest savings accounts.

Members will stay in the scheme post-retirement, the only difference from pre-retirement being that they make regular withdrawals from their pension accounts, having added to them during their working years.
This is a radical departure from Head 58 and Head 59 of the Bill, which envisage members leaving the scheme at retirement and taking a lump sum.

Finally, it will be possible to administer the scheme in the long-term for a management fee of 0.5% per annum, allowing this percentage to be inserted under Head 64.

5 These are personal estimates, based on projections of membership, assets under management and costs.
5 Appendix 1 Colm Fagan - Biographical Details • Past President of the Society of Actuaries in Ireland (2005 to 2007).

• Chaired Boards of Trustees of Group Defined Benefit and Defined Contribution Pension Schemes.

• Chairman of Standard Life International (2011 to 2018).

Served as Independent Non- Executive Director of other financial institutions after retiring from full-time work in 2008.
These included subsidiaries of SEB Group (Sweden), Hartford Financial (US), Hannover Re (Germany) and Barclays (UK).

I have retired from all but one.

My only remaining directorship is of a life insurance subsidiary of Berkshire Hathaway of the US (the parent company is chaired by Warren Buffett).

The company does not transact business in Ireland, so I have no conflicts of interest.

My sole concern in making this submission is better pensions for workers.
• Founder and Chairman of Life Strategies Actuarial Consultancy (1993 – 2008), which I • • established as a sole trader in 1993.

By the time I retired in 2008 the firm employed 20 consultants and was a recognised leader in international life insurance consulting.

The firm has since changed its name to Milliman Ireland.

Before forming Life Strategies, I was Finance Director, Chief Actuary and Company Secretary for Bank of Ireland’s insurance business.
I have authored or co-authored numerous actuarial papers, starting with a seminal 1977 paper on maturity guarantees, which was acclaimed as “remarkable” over 20 years later6 (having received little attention when it was presented in 1977).
My most recent was in November 2022, when I co-authored, with Brian Woods, a paper titled “Structured Retail Products: Meeting a Genuine Customer Need or Luring Savers into Gambling with their Money”, which we presented to the Society of Actuaries in Ireland in November 2022.

• Educational background: After joining Irish Life from secondary school as a trainee actuary, I qualified as a Fellow of the Institute of Actuaries in 1977.
I obtained a Masters’ Degree in Management from Trinity College, Dublin in 1991.

After retirement, I completed a BA with the Open University, graduating in 2013 with First Class Honours.

6 A Primer in Financial Economics”, British Actuarial Journal, Volume 8, Part 1, April 2002.

6