Global Aging 2016: Ireland's Aging Population Would Reverse Fiscal Gains In 10 Years Absent Reforms

Global Aging 2016: Ireland's Aging Population Would Reverse Fiscal Gains In 10 Years Absent Reforms Primary Credit Analyst: Alexander Petrov, London (44) 20-7176-7115; alexander.petrov@spglobal.com Secondary Contacts: Eileen X Zhang, CFA, London (44) 20-7176-7105; eileen.zhang@spglobal.com Marko Mrsnik, Madrid (34) 91-389-6953; marko.mrsnik@spglobal.com Table Of Contents Health Care Spending Presents The Greatest Policy Challenge No-Policy-Change Scenario For Ireland Leads To Lower Ratings By 2040 Alternative Scenarios Could Result In Significantly Different Economic And Fiscal Prospects The Effects Of Age-Related Spending On Sovereigns' Future Creditworthiness Are Simulations, Not Predictions Related Criteria And Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 6, 2016 1

Global Aging 2016: Ireland's Aging Population Would Reverse Fiscal Gains In 10 Years Absent Reforms According to the European Commission, Ireland's old-age dependency ratio--the number of people aged 65 and over, divided by the number of people aged 15-64--will rise to 45% in 2050 from 19% in 2015. S&P Global Ratings expects that Ireland's total population will continue growing and exceed five million by 2050, due to an increase in life expectancy and one of the highest birth rates in the EU. Nevertheless, we project that the working age population will fall to 56% of the total population by 2050, from 66% currently. In our view, Ireland's aging population will place substantial pressure on economic growth and public finances. Demand for public health care services, long-term care services, and state pensions--all of which are already under strain--could increase. The Irish government's policy changes over the past three years more than compensate for the slight deterioration in the demographic projections we mention above. However, without further reforms, we project that total age-related public expenditure in Ireland will rise to 19.6% of GDP in 2050, from 16.2% in 2015. Overview We expect that Ireland's total population will increase by 8% between 2015 and 2050, while the share of the working-age population will decline from 66% to 56%. Under the government's current policies, we project that annual age-related spending will increase by 3.4% of GDP. In the absence of further reforms or expenditure cuts in other areas, this growth in spending would weaken Ireland's fiscal position and reverse the current decline in net general government debt in 10 years' time. S&P Global Ratings' analysis of Ireland is part of a global study conducted to analyze the cost of aging. We presented our findings in "Global Aging 2016: 58 Shades Of Gray," published April 28, 2016, on RatingsDirect. The study explores various scenarios--including a no-policy-change scenario--and the implications that we currently believe these different scenarios could have on sovereign ratings over the next several decades. We have included an additional eight sovereigns in this year's report, which expands the scope of the study's coverage to a total of 58 sovereigns, representing 70% of the world's population. For the 50 sovereigns that we included in the previous edition of our Global Aging series, our findings this year provide an update of our analyses--including information on long-term demographic, macroeconomic, and budgetary trends, all in the context of the countries' current fiscal positions. Health Care Spending Presents The Greatest Policy Challenge The 3.4 percentage-point increase in age-related public expenditure between 2015 and 2050 is roughly in line with the WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 6, 2016 2

3.7 percentage-point increase that we project for the median of our sample of 58 sovereigns. We expect that roughly one-half of Ireland's age-related spending will go toward pensions, followed by health care (see table). We forecast that pensions account for two-thirds of the increase in age-related spending in 2015-2050, with one-third representing health care spending. Other projected changes have no net effect on age-related spending. The Irish government has been proactive in reforming its pensions policy. In 2014, it increased the retirement age to 66 and set out further increases for the 2020s. In addition, the government has modified public sector pension schemes to improve their sustainability, and has introduced additional incentives to encourage saving in occupational pension schemes in the private sector. Health care spending is under increasing upward pressure, yet the Irish government faces significant challenges in modifying health care policy. Public health care expenditure has exceeded the budget by 0.1%-0.3% of GDP annually in the past few years, in contrast to a rapid consolidation of spending in other government departments. This is despite a high contribution from private health care insurance and the means-testing of free primary health care. According to the Organization for Economic Cooperation and Development (OECD), only 68% of Ireland's health expenditure is publicly funded, against an average of 73% and a median of 76% among all OECD members, as of 2012. In 2014, the Irish government proposed introducing a universal health insurance model to even out health care provision across different population groups and introduce greater choice in the health care system. However, the Economic and Social Research Institute, an Irish government think-tank, calculated that the potential efficiency gains achieved through a clearer purchaser-producer divide would be more than offset by costs associated with the demand for previously unmet services, and, together with a reduction of out-of-pocket co-payments, lead to a 3%-11% increase in costs. The government has since postponed the introduction of the reform, illustrating the challenges of maintaining both the adequacy and sustainability of health care expenditure. Such dynamics suggest a substantial deterioration of Ireland's budgetary position in the long term. If unmanaged, the weight of general government spending--including social security--could rise significantly as age-related spending increases, coupled with a rising interest bill as deficits and debt mount. Our analysis suggests that without fiscal or structural policy reforms, the increase in age-related spending would reverse the current decline in net general government debt in 10 years' time. By 2050, net debt could rise to 131% of GDP in Ireland, just below the sample median of 134% of GDP. No-Policy-Change Scenario For Ireland Leads To Lower Ratings By 2040 Such macroeconomic and fiscal dynamics imply downward pressure on the current 'A+' long-term foreign currency sovereign rating on Ireland. Based on the fiscal projections of our study, we have derived hypothetical sovereign credit ratings for Ireland (see table). In practice, we take a large number of factors into consideration when determining sovereign credit ratings (see "Sovereign Rating Methodology," published Dec. 23, 2014). In the very long term, however, prolonged fiscal imbalances and wealth (as measured by GDP per capita) tend to become the dominant factors. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 6, 2016 3

Using this approach, our 'A+' rating on Ireland would likely come under increasing pressure in the 2040s. By 2045, we expect that Ireland's fiscal indicators would have weakened such that they would be more in line with sovereigns currently rated in the 'BBB' category, because, in our view, the projected improvement in GDP per capita would not be enough to offset the potential fiscal deterioration. However, Ireland's future budgetary deterioration now appears to be less challenging than it did in 2013. The two main reasons for this are a significant improvement in the sovereign's budgetary position since 2013, and a lower projected increase in age-related spending. Ireland's budget deficit halved between 2013 and 2015, and we project that it will continue to decrease, albeit at a slower pace. Strong nominal GDP growth in 2014-2015 has also reduced debt as a share of GDP. The Irish government's policy changes more than compensate for a slight deterioration in some of the demographic projections since our 2013 report, such as lower growth in the working-age population and a higher projected old-age dependency ratio. This leads to an overall reduction in projected pensions spending of 1.4% of GDP. Other elements of projected age-related spending have fallen as well, but to a lesser extent. Alternative Scenarios Could Result In Significantly Different Economic And Fiscal Prospects In addition to our no-policy-change scenario, we have considered several other long-term scenarios (see table). Two of these scenarios are: i) Ireland undertaking radical structural reforms of its social security system, including freezing all age-related spending (as a percentage of GDP) at the current level; and ii) balancing the budget by 2019. The latter scenario is close to our baseline fiscal forecast, and therefore the difference between that and the no-policy change scenario is small. In contrast, further structural reforms would result in a notable long-term fiscal improvement compared to the baseline, as the outcomes under scenario three in the table show. The Effects Of Age-Related Spending On Sovereigns' Future Creditworthiness Are Simulations, Not Predictions Our no-policy-change scenario for Ireland, as for the other 57 sovereigns we cover, is not a prediction. Rather, it is a simulation that highlights the importance of age-related spending trends as a factor in the evolution of sovereign creditworthiness. In our view, it is unlikely that governments would, as a general matter, allow debt and deficit burdens to spiral out of control, or that creditors would be willing to subscribe to such high levels of debt. In fact, as we have observed for many sovereigns in our 2016 Global Aging report, governments are able to confront the prospects of unsustainably rising debt burdens by implementing budgetary consolidation or by reforming their social security systems. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 6, 2016 4

Aging Population Data And Scenario Results: Ireland 2015 2020 2025 2030 2035 2040 2045 2050 Demographic and economic assumptions Population (mil.) 4.7 4.6 4.6 4.6 4.6 4.7 4.8 5.0 Working-age population (% of total) 65.7 63.4 63.3 63.1 61.9 59.3 56.7 55.7 Elderly population (aged over 65; % of total) 12.4 15 17.1 19.4 21.4 23.1 24.5 24.9 Old-age dependency ratio (%) 18.9 23.6 27 30.7 34.5 39 43.2 44.7 Real GDP (% change) 7.8 1.4 1.4 1.8 1.7 1.4 1.4 1.9 Age-related government expenditure (% of GDP) Pensions 7.5 8.0 8.7 9.1 9.6 10 10.2 10 Health care 6.1 6.3 6.6 6.9 7.2 7.3 7.3 7.3 Long-term care 0.7 0.7 0.8 0.9 1.0 1.1 1.2 1.3 Unemployment benefits 1.9 1.5 1.3 1.2 1.0 1.0 1.0 1.0 Total 16.2 16.5 17.4 18.1 18.8 19.3 19.7 19.6 Scenario 1: No policy change (% of GDP) Net general government debt 88.5 71.3 71.7 76.2 84.0 96.9 113.8 130.7 General government balance (2.3) (1.3) (3.0) (3.9) (4.9) (6.1) (7.3) (8.0) General government expenditure 36.3 34.8 36.5 37.4 38.4 39.6 40.8 41.5 Interest payments 3.2 3.1 4.0 4.1 4.4 4.9 5.7 6.5 Hypothetical long-term sovereign rating A aa a a a a bbb bbb Scenario 2: Balanced budget in 2019 (% of GDP) Net general government debt 88.5 84.0 77.0 73.5 72.8 76.3 83.0 89.3 General government balance (2.3) (0.2) (1.7) (2.2) (2.8) (3.5) (4.2) (4.4) Hypothetical long-term sovereign rating A aa aa aa a a a a Scenario 3: No additional age-related spending (% of GDP) Net general government debt 88.5 70.3 66.0 61.4 56.1 51.3 46.4 40.4 General government balance (2.3) (0.9) (1.5) (1.3) (1.0) (0.8) (0.6) (0.3) Hypothetical long-term sovereign rating A aa aa aa aa aa aaa aaa Scenario 4: Lower interest rate (% of GDP) Net general government debt 88.5 65.0 59.9 57.4 58.0 62.5 70.0 76.9 General government balance (2.3) (0.6) (1.3) (1.8) (2.5) (3.3) (3.9) (4.1) Hypothetical long-term sovereign rating A aaa aa aa aa a a a Scenario 5: Higher growth (% GDP) Net general government debt 88.5 68.9 65.2 65.2 68.4 75.7 86.0 95.5 General government balance (2.3) (1.1) (2.6) (3.2) (4.0) (4.9) (5.8) (6.1) Hypothetical long-term sovereign rating A aaa aa aa aa a a a Related Criteria And Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 6, 2016 5

Reports published on RatingsDirect Global Aging 2016: 58 Shades Of Gray, April 28, 2016 Sovereign Rating Methodology, Dec. 23, 2014 Global Aging 2013: Rising To The Challenge, March 20, 2013 Mounting Medical Care Spending Could Be Harmful To The G-20's Credit Health, Jan. 26, 2012 Global Aging 2010: An Irreversible Truth, Oct. 7, 2010 Global Aging 2010: An Irreversible Truth--Methodological And Data Supplement, Oct. 7, 2010 What A Change A Year Makes: Standard & Poor's 2007 Global Graying Progress Report, Sept. 19, 2007 Global Graying: Aging Societies And Sovereign Ratings, June 27, 2006 Reports not published on RatingsDirect De la Maisonneuve, C. and J. Oliveira Martins, "A Projection Method for Public Health and Long-Term Care Expenditures," OECD Economics Department Working Papers, No. 1048, OECD Publishing, June 2013. http://dx.doi.org/10.1787/5k44v53w5w47-en Economic Policy Committee and European Commission, "The 2015 Ageing Report: Economic And Budgetary Projections For The EU 28 Member States (2013-2060)," European Economy, No. 3/2015 ILO, "World Social Protection Report 2014-15: Building economic recovery, inclusive development and social justice", June 2014 IMF, "Fiscal Monitor - Acting Now, Acting Together," April 2016 OECD (2016), GDP long-term forecast (indicator). doi: 10.1787/d927bc18-en (Accessed on 10 April 2016) UN, "World Population Prospects: The 2015 Revision," http://esa.un.org/unpd/wpp/download/standard/population/, accessed on 15 April 2016. OECD statistics stats.oecd.org An Examination of the Potential Costs of Universal Health Insurance in Ireland https://www.esri.ie/pubs/rs45.pdf Only a rating committee may determine a rating action and this report does not constitute a rating action. Additional Contact: SovereignEurope; SovereignEurope@standardandpoors.com WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 6, 2016 6

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