Limit choice to tackle unsuitable retirement decisions, says OECD

Britain is not alone in the challenge of getting people to save for pensions, according to the Organisation for Economic Co-operation and Development (OECD).

While all 36 OECD nations face the same pension challenges – demographics coupled with a low growth/low interest rate economic environment – how they respond varies, private pensions analyst Stéphanie Payet said.

Speaking at a Barnett Waddingham conference on 26 September, she said: “The implications for all pension systems, whether publicly financed or on a pay-as-you-go basis, are similar.”

“Everyone is struggling to increase participation rates, whether in voluntary or mandatory schemes,” she continued. “Some recognise their design of pension systems comes up against behavioural bias to make the right decisions. Some countries recognise this and are trying to find ways to counter bad decisions.”

Whatever the type of scheme, participation is the first problem. There is a “massive” trend towards auto enrolment (AE). While there have been success stories in reversing the decline in participation – most notably from New Zealand and the UK – this has not been universal.

“Different factors have had bigger impacts in some countries compared to others,” noted Payet. In some countries, there is no mandatory enrolment while some find greater take-up if it is discretionary.

However, AE is only one lever to pull. The default options available can also influence participation.

“AE is just one step – an important one, but just the first step,” noted Payet. “Saving enough, and in an appropriate investment strategy, ensuring fees are not outrageous and there are good plans for pay-out with options is important.”

There need to be good default strategies that at the least protect people close to retirement for losses, she said. Where people have complete freedom, as in the UK, there is often no way to know what people do at retirement.

People need to think of the pay-out phases not in isolation but in a way that complements the pay-as-you-go public system and protects longevity risk, Payet noted.

“We need to make sure people think about the future and the ability of the scheme to continue to pay out at a proper level. Most people underestimate their life expectancy and this will have an impact on the types of pay-out they may choose,” said Payet.

Some countries have mechanisms in place to protect people, but even in those cases these may not be enough, particularly if there are time limits on the coverage.

And there has also been a move to put more responsibility on individuals, with savers often asked to make myriad decisions, such as where and how much to invest, which provider, and when they will retire.

“People make unsuitable decisions, even if they have good intentions,” Payet said.

Some countries are taking this into consideration in the design of pension systems, putting in features such as auto-escalation.

“If there is a plan, and it is automatic, most people will follow it,” says Payet, adding: “Default options are very useful when people are unable to choose.”

Many countries also recognise that pension products are complex and a lot of work is centred on making it easier for people save and understand the choices open for them. One way to help is to limit the options available.

Rather than presenting 40 or 50 investment strategies to choose from, offering only three or five where people can understand the differences is favoured, Payet said.