a new way to think pension management

Transcription

1 a new way to think pension management Pension Reform: Key Findings and Possible Action Items Rotman ICPM Discussion Forum Helsinki, Finland October 2015

2 The Rotman International Centre for Pension Management is a global, research-based network of pension delivery organizations that stimulates leading-edge thinking and practice about pension design and management. ICPM brings together an influential community of pension industry professionals to share knowledge and interact with academic researchers pursuing pension related research. ICPM organizes interactive Discussion Forums involving practitioners and researchers, and provides funding for objective and transformative research to support effective management and innovation in pension and investment organizations. With its partner, the Rotman School of Management at the University of Toronto, ICPM is proud to offer a highly respected pension governance education program the Board Effectiveness Program for board members of international pension and long-horizon investment institutions. U P C O M I N G D A T E S Discussion Forums Boston: June 6 8, 2016 Asia: October/November 2016 (date/location pending) Toronto: June 5 7, 2017 Netherl ands: October 2 4, 2017 Board Effectiveness Program (Toronto) BEP 7: November 30 Dec. 4, 2015 BEP 8: April 4 8, 2016 Program Fees $6,950 + t ax 2

3 E X E C U T I V E D I R E C T O R S M E S S A G E We had a terrific discussion in Helsinki about the state of pension reform around the world. Pension systems differ widely from country to country, and we are still struggling to construct systems that meet the triple hurdles for pension adequacy, sustainability and integrity. What struck me in Helsinki is how complex and difficult pension reform and communication is. Getting the public engaged in slow and incremental pension reform is challenging and requires strong pension reform organizations and processes. The experience of the Finnish Centre for Pensions, our co-host for this forum and a major participant in national policy reforms, provides a good example of this need. We thank our co-hosts for their involvement and the important insights they shared about the Finnish experience. Creating a basic understanding about pensions is another major challenge. Even within ICPM, we have trouble understanding each other s systems. How then, can we explain pensions to workers at various stages of their careers especially critical decisions required at retirement? As our dinner speaker, Stig Pramming, reminded us in his humorous way, how people feel when they get older also needs to be considered in pension system design. None of this is easy. On the positive side, the complexity of pension change is, I believe, the reason why attendees were so engaged in our discussion in Helsinki. We still have a lot to learn from one another in the ICPM network. Attendee Facts 68 attendees from 13 countries Representatives from 22 Research Partners, 7 universities and 5 pension think tanks participated What did we learn? Pension security is the top priority for most people. Polls and research presented at the forum, as well as anecdotal experience of pension plans, suggest that most people stay in default plans and only a small percentage would blow their retirement savings if given the chance. Simplicity is essential. We had vivid discussions about the trade-offs involved in setting defaults, particularly the need for decumulation defaults that make retirement decisions easier while giving people enough control over their savings. Related to simplicity, we discussed whether process or product innovation will best serve participants needs. We need better pension communication and technology. The public does not understand pensions. Providing simple information and tools that help them see their entire retirement picture and make informed decisions takes commitment, investment, technology and people on the part of pension organizations. Working longer is part of the sustainability solution, but aging workers are going to need support and investment in the workplace to remain productive over longer careers. Raising managers awareness of declining productivity and the need for late-career training is important to making this solution work. We are pleased to share key findings of our Discussion Forum. We invite you to share this summary and the background resources from our event with your colleagues. Rob Bauer Executive Director International Centre for Pension Management 3

4 EUROPEAN MONETARY POLICY AND ITS TRANSMISSION FINNISH PENSION REFORM: WHAT CAN WE LEARN? We ll extend the program as long as it s necessary. Erkki Liikanen, Governor of the Bank of Finland From a pension finance perspective, we re better off than probably ever. Mikko Kautto, Finnish Centre for Pensions Bank of Finland Governor Erkki Liikanen opened the forum with a strong message that European central banks remain committed to actions needed to stabilize markets and lift economic growth, even as room to further lower interest rates has been limited. Mr. Liikanen discussed impacts on financial markets and expectations, inflation and economic output of the European Central Bank s January 2015 decision amid weak inflation forecasts to expand its asset purchase program. What does the Expanded Asset Purchase Program mean for pension funds? A lot, since EA government bonds make up 24% of assets held by pension funds and insurance companies. Mr. Liikanen said the program that has increased lending volumes and reduced deflation risk would be extended as long as necessary. Pension plans have felt the effects of the EAPP and similar programs through lower bond yields and a corresponding rise in pension liabilities. Mr. Liikanen pointed out that the EAPP increases the value of other assets, such as equities, but that the search for yield encourages risk-taking that can result in losses. In the long run, he said reaching targeted inflation and encouraging sustainable growth creates a positive environment for pension plans. He warned, however, that financial sector risks cannot be taken away by monetary policy alone and will require coordinated policies that address risk within the financial system as a whole. Hot discussion topics: Benne van Popta raised the point that EAPP is beneficial for governments but detrimental for pension funds. Mr. Liikanen acknowledged that low interest rates are difficult for pension funds, but emphasized that EAPP is a marathon and economic growth will benefit pension funds. Sudhir Rajkumar asked about the risks attached to exiting the program. Mr. Liikanen recognized that this will be the next challenge but said that at the moment, we still need to reach the 2% inflation target. ICPM was honoured to have the Governor of the Bank of Finland kick off our October Discussion Forum. Jukka Rantala and Mikko Kautto (both from the Finnish Centre for Pensions) discussed pension reforms in Finland. They argued there is still an urgent need for reforms despite recent changes that have limited early retirement, cut pension benefits and strengthened the financing base for pensions. What can we learn from the Finnish experience? The speakers described several advantages from reforms easier administration, labour mobility, lower risks for employers but said that while the hybrid system balances sharing and control of different types of risks, it does not maximize or minimize any single feature of DB or DC plans (i.e., adequacy, sustainability or integrity). Several issues are driving the need for further reforms in Finland, such as concerns about sustainability and pension adequacy over longer lifespans, and the effects of higher contributions on the labour market. The goal of current reform is to raise the retirement age, manage rising pension costs and increase future pensions while keeping contributions as stable as possible. Despite these challenges, Mr. Kautto asserted that the system is working: From a pension finance perspective, we re better off than probably ever, he said. Questions & hot topics: The audience engaged in lively discussion about whether a hybrid system is more sustainable, and what individual rights people have in it. They also talked about how to set up such a system to share risks. Participants discussed how much power social partners and the government have when it comes to reforms (e.g., tackling productivity of elderly)? Finland s hybrid pension model combines features of traditional flat-rate public pensions and earnings-based private pensions within the same system. The Finnish Centre for Pensions, ICPM s Discussion Forum co-host, employs nearly 390 pension experts and offers research and services supporting pension reform and implementation of the pension provision. 4 Presentation and background materials can be accessed on ICPM s website

5 PANEL: LATEST DEVELOPMENTS AND PENSION REFORM ACROSS THE GLOBE When you pick your pension design, you pick your problems and challenges. Guest moderator Benne van Popta, PMT-MN Pension systems all over the world differ in their goals, design and reform objectives. Helen Dean (NEST), Casper van Ewijk (Netspar) and Ole Beier Sørenson (ATP) discussed reforms in the UK, Netherlands and Denmark respectively and key outcomes. What can we learn from the UK experience? Pension reforms in the UK have sought to reduce complexity and encourage additional savings, and introduced automatic enrolment through the establishment of NEST. The government surprised the industry this year by introducing UK Pension Freedom Day legislation that gives people full control to use their retirement savings to purchase annuities, take a lump sum, or draw down an income. Ms. Dean said automatic enrollment has improved pension coverage, but warned that the system faces an adequacy problem. This challenge has spurred debate on how to encourage people to save more. The Dutch experience? Pension adequacy is not a problem in the Netherlands but the public is generally not aware that pensions have become more risky in a low interest environment. The regulatory framework is still built on riskfree nominal pensions. Low interest rates have increased volatility in funding ratios, resulting in a need to cut pension benefits. According to Mr. van Ewijk, the discussion on funding rates failed and a barrier to a more fundamental reform is the fact that occupational pensions are the domain of social partners. The Danish experience? Mr. Sørenson highlighted two problems in the Danish system: Rationality problem: Public benefits should go to the neediest pensioners, however income testing translates into higher implicit taxes for low and mid-income pensioners and hence weaker incentives to save. Legitimacy problem: Saving is voluntary for some people, which can jeopardize the system. Questions & hot topics: If people have full control over their retirement money, will they blow it all? Information and research presented in other sessions suggests this is not likely the case because pension security is people s top priority. The audience discussed to what extent the nature of work should be considered when setting retirement age. The issue of whether DB is already dead was raised. Mr. Sørenson argued that having complementary DB and DC schemes within a pension system is important because both have advantages. Barbara Zvan (OTPP) gave the example of a DB-like plan currently being set up in Ontario but added that this is an exceptional case. Who owns reform industry or legislators? Fieke van der Lecq (Erasmus School of Economics) discussed the informal (e.g. network of economists) as opposed to the formal structure (e.g. social economic council) for reforms in the Netherlands, while Ms. Dean said that with the current freedom and choice agenda, politicians looked strong but industry looks weak. THE IMPACT AND EFFECTIVENESS OF AUTOMATIC ADJUSTMENTS TO LONGEVITY This is a funding crisis, not an unforeseeable natural disaster. Michael Preisl, ATP Jukka Lassila (Research Institute of the Finnish Economy) and Michael Preisl (ATP) talked about challenges for implementing automatic adjustments to longevity in pension systems. Past reforms in Finland have tackled the adjustment of benefits (2005) as well as increasing and tying retirement age to longevity (2017). Mr. Lassila noted that while the current longevity factor was difficult to communicate, explaining the new factor is even harder since it includes the projection of future mortality. Mr. Preisl argued that the problem is not longevity, which was foreseen, but severe underfunding. In his view, automatic longevity adjustments will not solve the problem because existing second pillar legal contracts are difficult to change. Delaying retirement is, however, part of the solution for individuals. Mr. Preisl explained that most Danish pension funds are collectively owned by members, and so the members either could bankrupt their own funds, or give up on interest rates and mortality related guarantees, which is what has happened. He asked whether longevity is really a risk, or rather one of the two yardsticks to distribute pension fund wealth in a fair way. He said it is better to be approximately right than precisely wrong and argued that we should accept that there is risk involved in modelling and must bear it. Action items for plan participants: Individuals should diversify their risk of death; Buy an annuity, buy a product that improves your standard of living now Live Poll: Who should bear longevity risk? Mr. Preisel began this session by asking who should deal with the consequences of aging communities? 75% of attendees said society should bear the risk, 19% said individuals, and 6% said collective pension funds should. Mr. Preisel said that society is often seen as the natural bearer of risk but he expected a higher response for collective pension funds, since in many countries the second pillar is larger than the first. Presentation and background materials can be accessed on ICPM s website 5

6 SETTING PROPER DEFAULTS IN DC PLANS Any default, by definition, is a compromise. Jack Gray, Paul Wolley Centre for Market Dysfunctionality In this session, Ernesto Brodersohn (CONSAR), Yvonne Sin (Towers Watson Hong Kong), Scott Hartley (SunSuper) and Alan Brown (Schroder Pension Fund) agreed that while there is no proper default for every situation, defaults certainly offer advantages. The session was moderated by Jack Gray from the Paul Wolley Centre for Market Dysfunctionality. Mr. Gray began by polling the audience on competition, investment strategies, and existing and better defaults. Asked if competition between DC funds can improve outcomes for retirees, 64% said yes. Mr. Gray argued against competition due to asymmetric information, while some in the audience supported competition as it may decrease costs, and drive up innovation and choice. Asked whether passive investing is the preferred approach for the default, there were opposing views but 65% agreed. Key points: Mr. Brodersohn outlined how important auto enrollment is in the Mexican system, while also keeping freedom of choice so that people can switch administrators. In the young Hong Kong system, Ms. Sim said that low contribution rates, perceived high costs and a general lack of interest and pension knowledge are major problems. In the Australian system, Mr. Hartley said the main goal is to engage participants and properly inform them about their financial situation. We re absolutely passionate about the engagement of our members and of course, that costs money, technology and people, he said. In the UK where decumulation options have expanded, Mr. Brown said younger generations in the Schroder fund might achieve a replacement rate of 50% without first pillar pensions, while older generations only achieve 10-15%. Other income sources are important and there is a need for better technology to help participants understand their entire retirement picture. Action items: Speakers shared their views on what to consider when setting defaults: Make options simple to understand Many people value individual choice, but Think about the needs of three groups: 1) those who will make decisions need choices; 2) those who are unlikely to make decisions need structured guidance and limited choices; and 3) true defaulters who are unwilling or unable to make decisions need suitable defaults Align risk with different profiles, but accept there will be limited financial literacy and that factors other than returns will drive some decisions Better information and clarity on choice outcomes can support informed decisions Uptake on opt-in mechanisms to encourage additional savings can be slow; short-term incentives can be effective Engaged members enjoy higher balances, highlighting the importance of investing in good communication They [the participants] want to know that it s their money. Ernesto Brodersohn, CONSAR Questions & hot topics: A good discussion followed on whether people are able to decide on defaults at all. Should defaults consider risk appetite and work histories, not just age? Additional factors have received less consideration in earlystage pension funds (e.g., Hong Kong) and due to the complexity of the decisions. Two speakers agreed that this is the next big topic for communication and planning commissions. What is the value of pension funds in respect to cost structures? The audience raised points that pension funds outperform the markets and offer more diversification than retail funds, and economies of scale exist with larger funds having lower costs per member. High interest in this topic and the subsequent session on decumulation defaults suggests ICPM could return the subject in a future discussion forum. SETTING PROPER DEFAULTS FOR RETIREMENT INCOME: DECUMULATION PHASE We had a vibrant rountable discussion on the comparative advantages and disadvantages of various decumulation options. Mark Fawcett (NEST) and Brad Holzberger (QSuper) introduced the session by discussing the challenges of setting defaults for the decumulation phase and sharing the experience of their respective pension plans. They said that participants value choice and control over their money but often do not have the investment knowledge, ability or desire to make these critical decisions at retirement. Key points: 99.8% of NEST s members stay in the default fund. Mr. Fawcett pointed out that participants cannot be expected to be investment experts at age 65 (even if they have been saving for 40 years). At QSuper, while members can take out everything when they approach retirement, Mr. Holzberger said they usually do not. On average they take out 15% to pay down debts, go on holiday or pay for other immediate expenses. 6 Presentation and background materials can be accessed on ICPM s website

7 Mr. Holzberger explained that although Australian members already carry all investment risk, they also need to be aware of running out of money if they live to full life expectancy. For Mr. Holzberger, the problem with longevity is not that members are getting older (DB problem), but that the distribution of longevity is really wide. Live Polls: What do most people want from a retirement product? The room unanimously agreed that security is the highest priority for participants, trumping options to take money out, grow it during retirement or leave it to family members. Is it reasonable to default retiring members into pools that share mortality credits to manage longevity risk? 84% of attendees said yes, but Mr. Holzberger pointed out that members see it as their money and do not want to give it to someone else. Table discussion: Comparing defaults Participants were then invited to compare the strengths, weaknesses and principles for decumulation defaults used at NEST and QSuper and give their feedback. (Presentation materials outlining decumulation defaults for each organization are available on ICPM s website.) Strengths: Allows for competition; encourages innovation, different kind of thinking Pooling strategy is good, e.g., children with a better education than their parents may not need bequests Mortality premium is good in the long term Deferred annuity/longevity insurance is a good strategy Clarity: easy to follow, useful for communication Income for life is a good strategy: insurance against running out of money Weaknesses: Competitive pricing of annuities is not available Complex and difficult to communicate to members Pooling: risk of selection bias Inflation risk in case of fixed annuity Action items: Solutions should emphasize simplicity, value, freedom to opt out and a clear choice architecture Develop a default decumulation path that does not assume investment knowledge in participants and acknowledges that people will better understand their income needs as they enter retirement But don t overthink it: The default path should allow people to get on with their life and have a sustainable income for retirement. Keep it simple. Consider what members will have from the first pillar and social services (i.e., medicare) and therefore, what options they will need Encourage members to take advice, and apply investment and longevity risk-sharing Live Poll: Investment strategies and risk Attendees agreed that people generally want security, but there was healthy discussion about risk tolerances in relation to defaults. The majority polled (75%) said they would recommend maintaining a conservative strategy for DC plan members who have saved enough to achieve a 50% replacement rate of income. 18% said higher investment risk was appropriate because life expectancy is long and in the long run investment risk in always rewarded. A small percentage agreed with higher risk because it can improve retirement outcomes and most retirees want more than a 50% income replacement. Questions & hot topics: What s the best way to communicate the defaults for decumulation? Mr. Fawcett suggests to keep it simple, explain the key elements and try to understand fears of members by talking to them. Communicate accumulation and decumulation as one insurance package from a provider who is there to manage your retirement income risk. SOCIO-ECONOMIC DIFFERENCES, ACTIVE AGING AND THE PENSION SYSTEM Working longer to support pension sustainability means that workplaces must address the question of how to keep older workers productive over longer careers. Andries de Grip (Maastricht Univeristy) and Noora Järnefelt (Finnish Centre for Pensions) looked at the socio-economic impacts of pension reforms and reform proposals. Mr. de Grip s research with APG examined the effects of Dutch policy reform that abolished early retirement opportunities for people born in 1950 or later. Ms. Järnefelt elaborated on some differences between socioeconomic groups, highlighting factors around fairness that should be considered in pension reforms. Key findings from the Dutch experience: People have not postponed retirement as much as expected Postponing retirement demotivates people and worsens their mental health People who lose their jobs when 55 years old and older are more likely to be long-term unemployed Productivity and job satisfaction can be improved by investments in training Presentation and background materials can be accessed on ICPM s website 7

8 Key findings from the Finnish Centre for Pensions: Life expectancy for the lowest income quintile has not risen, while it has for others Blue-collar workers expect to use early retirement provisions the most There are nearly no differences in retirement expectancies between socio-economic classes, while women may expect to spend longer in retirement Blue-collar women are most at risk of periods of unemployment; they have the highest return on pension contributions because of shortened working lives and long retirement time expectancy While not often discussed, this research acknowledges that life expectancy varies for different socio-economic groups, which means that workers with below average life expectancy could get less from pension plans than those with higher education or better access healthcare. Rather than looking at socio-economic differences solely from the perspective of pensions, policymakers need to think about pensions in relation to education and healthcare policy as well. Action items: For HR managers: Make managers aware of declining productivity for older workers and increase their involvement in sustaining productivity and job satisfaction Increase participation in training for late-career workers For regulators: Phase in later retirement gradually to mitigate negative impacts on workers Research on division of work and retirement can change perceptions of fairness of pension reforms Questions & hot topics: Should blue-collar workers be required or encouraged to switch professions in the middle of their careers to sustain their productivity for more years? Mr. de Grip proposed further collaborative socio-economic research with pension funds to understand participants need and the far-reaching consequences of pension changes on aspects such as worker motivation and performance. Mr. Kautto and Mr. Sørensen opposed this view, asserting that it is better to treat the problems where they originated (Mikko Kautto), encouraging pension funds to concentrate on their financial responsibilities while policymakers and companies should consider workplace and broader socioeconomic impacts. DEVELOPING COMMUNICATIONS ABOUT COMPLEX DECISIONS What experts find compelling is not necessarily what non-experts need to make wise decisions. Wandi Bruine de Bruin, Leeds University Business School Wandi Bruine de Bruin (Leeds University Business School) and Cäzilia Loibl (Leeds University Business School, Ohio State University) concentrated on communicating about complex topics. Ms. Bruine de Bruin argued for communicating with simplicity when providing information for complex decision-making, such as retirement choices. She said that effective communication must be accurate (based on information from subject-matter experts) and understandable to non-experts; and has a better chance of being effective if it is framed by social scientists and tested before it is distributed. She warned that communication by domain experts is bound to be ineffective, saying that [w]hat experts find compelling is not necessarily what non-experts need to make wise decisions. Furthermore, agerelated decline in cognitive ability starts in early twenties, making complex information harder to process as people age. Ms. Loibl presented survey findings on financial decision-making related to Pension Freedom Day in the UK (April 6, 2015) the date UK citizens were given complete control over use of their retirement savings. The survey with 503 respondents found that: 45% would take the lump sum and less than half of these people said they would use part of the money for vacations and other purposes. It is notable that among this group of respondents, pension literacy is particularly high. Yet security was the highest priority for people s retirement money and very small percentages planned to have a good time or blow the pot. These results confirm the NEST research results presented by Mark Fawcett earlier that pension security is most important for members; however, they also showed evidence for policymakers worries that financial decisions are often based on the present, and that people typically have materialistic focus and underestimate life expectancy. Action items: Present information that audiences can understand Be aware that people are bombarded with information Build on audience s strength and experiences; focus on their interests in the subject, rather than what experts want to talk about Know your audience (social scientists can help) Take a less is more approach, communicating a single message or finding for clarity Hot topics: Communication and decision-making challenges led to a discussion about pension defaults. Mark Fawcett raised the point that decisions we ask people to make in the decumulation phase are more difficult than those in the during accumulation phase ignoring the general decline in cognitive ability. The group discussed whether this suggests the need for stronger defaults in the decumulation phase. 8 Presentation and background materials can be accessed on ICPM s website

9 I C P M R E S E A R C H P A R T N E R S / W o r l d w i d e Global Risk Institute World Bank A u s t r a l i a Australia Future Fund Australian Super QSuper Queensland Investment Corporation SunSuper J a p a n Nomura Research Institute N e t h e r l a n d s Algemene Pensioen Groep De Nederlandsche Bank MN PGGM Stichting Bedrijfstakpensioenfonds voor de Detailhandel C a n a d a Alberta Investment Management Corp. Alberta Local Authorities Pension Plan British Columbia Investment Management Corp. Caisse de dépôt et placement du Québec Canada Pension Plan Investment Board Healthcare of Ontario Pension Plan Ontario Municipal Employees Retirement System Ontario Teachers Pension Plan OPTrust Public Sector Pension Investment Board D e n m a r k Danish Labour Market Supplementary Pension Pensionskassernes Administrations (PKA Ltd.) F i n l a n d Finland State Pension Fund Ilmarinen N e w Z e a l a n d New Zealand Superannuation Fund S w e d e n Forsta Ap-Fonden (AP 1) U n i t e d K i n g d o m National Employment Savings Trust Railways Pension Trustee Company Ltd. Unilever Universities Superannuation Scheme U n i t e d S t a t e s California Public Employee Retirement System California State Teachers' Retirement System State Board of Florida Administration TIAA-CREF Washington State Department of Retirement Systems F r a n c e Etablissement de Retraite Additionelle de la Fonction Publique 9

10 International Centre for Pension Management 105 St. George Street, Room 457 Toronto ON M5S 3E6 Canada TEL Photo credit: Tuomas Elenius a new way to think pension management 2015 ICPM International Centre for Pension Management Rotman School of Management, University of Toronto CANADA