Tel: +1 604 609 3136
Written by: Neil Lloyd
The World Economic Forum (the “Forum”) research, in collaboration with Mercer and the OECD, highlights 11 strategic options to be considered in “shaping the silver society,” and encourages multistakeholder collaboration to improve retirement and health care provision around the world. Will it work to improve retirement for the majority of people? Essentially, this is too big a question for this article. However, we will look at some indicators of the current directions being taken by different stakeholders in the retirement arena, and ask whether the collaborative action urged by the report looks either likely or effective.
In all but the short term, retirement provision will depend almost entirely on the effective operation of defined contribution (DC) plans. For these, the importance of the roles played by the various stakeholders other than employer sponsors is very clear.
Governments create the environment
It is difficult for multinationals to establish retirement plans when rules and contexts are diverse between different countries. However, some common themes are emerging as governments share solutions to very similar problems. For example, increasing retirement ages is a sensible and common response to aging across many countries. Common approaches may make life easier for multinationals, and the Forum report provides a common set of options for countries to grapple with the question "Will that work well here?" (This approach was used, among other criteria, in our New Zealand report Securing Retirement Incomes.) Practical analysis of the effects and benchmarking of country initiatives will lead to both a better understanding of what really is best practice and a clearer path forward for multinationals faced with the challenges of globalization.
Financial service providers provide a variety of tools
The tools available from providers form the bedrock of plan operations. Clearly there is a challenge in the scenarios proposed by the first Forum report around the extent to which forms of long-term saving will be individual or collective – a key question.
Individuals are the recipients of the value
Individuals have to make certain key decisions. For example, they have to sign up for retirement savings plans. Strides are being made in promoting this by exploring the best ways to provide information and advice as well as how to present key decisions to employees, but their ultimate effectiveness as yet remains unproven.
In the rest of this article we take a look at some improvement initiatives of governments, and the issue of member behaviors, and we consider their effectiveness in relation to the strategies in the report.
Governments and personal accounts
Reflecting on current developments, one of the key reform initiatives is “personal accounts.” The UK has spent a lot of time developing its personal account system, but we are seeing similar initiatives in Canada (ABC Plan), US (Simplified IRAs), South Africa and India.
The objective of personal accounts is to provide well-managed, cost-effective retirement plans to a greater number of people (that is, to increase coverage). A material concern with many current arrangements is that the self-employed, smaller (and even mid-size) employers and the informally employed find it very difficult to obtain access to cost-efficient, well-managed DC arrangements. Hence, the idea is that by creating a multiemployer structure (personal accounts), economies of scale can be achieved. (Note: Large employers in developed countries already have access to various bundled or unbundled solutions to achieve these objectives.)
The introduction of personal accounts is consistent with a number of the objectives put forward by the Forum. For example, Strategic Option 8 refers to utilizing economies of scale and lowering costs.
There is little doubt that once a personal accounts system is mature and contains significant assets under management, there should be no reason that economies of scale cannot be achieved. However, it is likely that a personal accounts system will have “growing pains”; initially, there will not be large assets under management, so how will costs be kept low?
One possibility would be to take over existing occupational schemes. However, the introduction of personal accounts is generally seen as an additional option for retirement provision to achieve greater coverage. The replacement of occupational schemes with personal accounts is not the real focus; rather, the objective is to add people who are not in plans, not to convert existing membership. But therein lies the dilemma: People not currently in a pension plan will not have assets to bring into personal accounts. In addition, many smaller employers – often a target market for personal accounts – may have a less sophisticated administrative infrastructure, which can present cost challenges for personal accounts through additional payroll and membership interface problems.
A related challenge will be the ability of the personal accounts approach to encourage higher levels of retirement savings. We have seen occasions in the past where employers have actively encouraged further retirement saving; with personal accounts, the employer is less likely to be actively involved. The other challenge is the setting of minimum contribution rates. In Option 5, high default-contribution rates are proposed; the challenge is that minimum (or default) contribution rates often become the de facto maximum. Australia has seen this, where the mandatory contribution of 9 percent became the norm, and now there is an active process to encourage higher contributions.
A further challenge in the retirement system is the behavioral reality that individuals generally are looking for short-term gratification; longer-term saving is rarely a priority. This is an increasing problem with the “Generation Y” population, where their immediate priorities are issues such as gaining access to the housing market (with retirement plans a later problem to address). Hence, we are seeing a demand for more flexible retirement vehicles that can provide assistance for housing, health care or job loss. If we want to encourage greater retirement savings, we may need to think more broadly to ensure that individuals see some shorter-term, as well as longer-term, advantages of putting money aside for retirement. This seems very much in line with the Forum thinking of using property wealth as pension. However, the encouragement of flexibility and the coherence of these methods of saving need to be built in from the employee’s initial entry into saving and consistently encouraged throughout their careers.
The most complex issue facing personal accounts is that there is limited experience of their impact on existing retirement systems. There clearly have been some success stories, such as New Zealand’s Kiwisaver, but that initiative developed out of a specific set of circumstances. It will be interesting in 10 to 15 years’ time to review what impact the introduction of personal accounts ultimately has had overall.
Helping individuals: Education and behaviors
Interaction by sponsors with plan participants has come a long way. Many plans have developed sophisticated processes for participant communication and choice.
The assumptions once made – that plan members would understand their own objectives and needs, value choice and choose well – are being increasingly questioned as members appear challenged by their own unconscious behaviors, abilities, apathy and inertia. Plan sponsors and many fiduciaries remain bewildered as to why their members act the way they do. Their schemes offer a range of choices – from investment funds to flexibility in retirement – yet few members seem to choose well. Financial training and education are thus not innate, so it is in everyone’s interest to improve access to educational resources, as encouraged by the Forum strategy.
In the context of a retirement plan, a more holistic approach will yield better results and foster greater collaboration between sponsor and participant, which will benefit both. There is no doubt that members’ past behaviors affect their future decision making, be it choosing products in the supermarket or choosing which mortgage rate to select. It therefore follows that their past behaviors will influence the financial decisions they make. For this reason, financial education by sponsors is necessary to correct misperceptions and change behaviors, building on the general foundation established by government and provider information. Regulations governing advice and sales need to support these efforts (for example, by not using unnecessary and conflicting jargon), and the decisions that people are required to make should be simplified to the essentials.
On this last point, we have created possible ways in which the simplification of decision making can occur. Some examples are:
Fiduciaries have, in certain cases, utilized their own financial skills, investment knowledge and access to financial expertise to compose a range of well-structured investment strategies that consider the requirements of members with limited understanding or interest in their own pension needs.
Members who want more choice could be offered an extended range of funds. “White labeling” (that is, naming funds generically, for example, “Global Equities”) has also been used in certain countries to make replacing underlying fund managers easier and, ultimately, reducing legacy and inertia concerns.
These examples of how to simplify decision making are a summary taken from the first article in our series on plan participant behaviors, “The psychology behind pension plan decisions – Part 1: Enrollment” which appeared in our Global Retirement Perspective, Issue 3, 2009.
Overall, our consideration of these two current strategic areas not only demonstrates that the strategies proposed by the Forum report are helpful, but also that they will need collaboration to succeed. The full report is a useful blueprint to test proposals. As demonstrated, there are ways of improving outcomes through education and improved efficiency, and no doubt, other areas of the report will yield further opportunities.
+1 604 609 3136
Neil Lloyd is a principal and a senior consultant in Mercer's investment consulting business in the Vancouver office. He also is the intellectual capital leader of the company’s global DC consulting business. With extensive actuarial, investment and international expertise, Neil advises clients on the setting of investment policy, asset-liability management, and selection and evaluation of investment managers for both defined benefit and defined contribution plans.