Keeping the water out for low income groups.

As the era of defined benefit draws to a close, saving has to become more attractive, particularly to people with low income. The question is how? Both David Pitt-Watson and Dr. Alwin Oerlemans agree that auto-enrollment should play a crucial role.

CorleyDavid, Alwin – thank you for your time. As state pensions across Europe cut back on retirement benefits, do you think Europeans are aware they need to save more?

Pitt-WatsonCertainly not in the United Kingdom. We have close to 50% of the people in employment not saving for retirement, and this seems mostly due to a gap between what people want and what they are offered. Retirement schemes are often perceived as too complex and not trustworthy enough.

OerlemansMost people in Europe trust that either the state or their employer will take care of their retirement income. In the Netherlands, although we have compulsory second-pillar saving in most sectors, there still is a gap between expected and actual income. We need more transparency and better communication.

CorleyI agree, we have a low provision rate which further decreases with lower income groups and people are put off by complexity, lack of accessibility, jargon and a fear of making the wrong decision. How would you suggest to make saving more attractive?

OerlemansIt’s the governments’ task to make people aware of the importance of financial planning. Governments across Europe need to do more in this regard, and the asset management industry should also assume greater responsibility in helping people prepare financially for their future.

Pitt-WatsonTo make retirement saving more attractive, we have to start with auto-enrollment through employer schemes. It helps keep the costs down and allows pension benefits to increase.

CorleyKeeping costs low is important, as employers must be willing to offer schemes. There is a tendency to focus on workplace pensions, for example the National Employment Savings Trust (NEST) in the UK, and although this is very admirable, employers have to be comfortable the scheme fits in smoothly with the wider compensation and benefits system they are offering.

Pitt-WatsonThat is why we need a consensus, particularly for smaller companies. We need to agree on auto-enrollment, albeit with an opt-out option, and we have to make it transparent for savers. They need to know what the investments will be and what the charges will amount to. With the legacy of defined benefit (DB) still lingering and employers’ understandable reluctance to commit to further DB liabilities, we need a sensible debate about what scheme is best suited to replace DB, and we need it now. In the UK, a lot of people will be extremely disappointed with their retirement income, yet since that problem doesn’t present itself for another generation, politicians are willing to leave it alone.

CorleyDo you expect policy-makers to pick up the topic soon?

Pitt-WatsonI have a sense that we will see much more discussion, and I hope that will result in action. Denmark and the Netherlands have very comprehensive auto-enrollment systems at low cost. Partly as a result, the pension poverty level in the Netherlands is one of the lowest. If a typical British and a typical Dutch saver put away exactly the same amount in reasonably good funds in either country, the Dutch person ends up with a 50% higher pension. That may explain why you hear so many Dutch voices on Spanish beaches.

OerlemansSpanish beaches are undoubtedly warmer than the Dutch seafront. But the crucial difference is that in the Netherlands, employers and employees, not the state, jointly created a successful private pension. It is also a clear understanding that by creating scale, costs can be lowered and risks can be shared. This cooperation suits us well as we have a culture of joining forces to keep the water out.

CorleyThe cooperation between employers and employees is really important; assuming this exists, what are your thoughts on the structure of auto-enrollment saving schemes?

Pitt-WatsonThe notion of having both sides represented and having a trustee-based governance is quite important. People need to rest assured that, wherever their money is, it is looked after by experienced professionals who have the saver’s interest at heart. This requires a high degree of trust.

CorleyIn a trust-based scheme, people are likely to receive a reasonable product choice, yet the counterargument is that it will be an average choice, imperfect for anybody. Which argument do you find more convincing?

Pitt-WatsonI am convinced people want a pension structure they can trust, like their doctor who doesn’t prescribe medication unless necessary. Complex choice is not what people are after. An ideal system should combine auto-enrollment with a simple default choice, which I expect to be preferred by 80% of the savers. A more complicated system can be offered to those who want more choice, but that adds costs. Costs matter – 1% annual fees will result in losing approximately 25% of the potential pension in cost, while 2% equals about 50% of the potential pension. The difference between 1% and 2% is not the difference between getting 99 and 98 cents on the euro, it is the difference between 75 and 50 cents on the Euro.

OerlemansIn the Netherlands, second-pillar providers do not aim at maximizing their own return. All excess profits go back into the scheme to the benefit of the participants. In addition, I believe costs of new products should be reduced, possibly even so far as to make institutional prices available to individual investors.

CorleyIn an ideal world where savers from a low income group make the best choice today, how can we ensure that they remain financially healthy until and beyond retirement 30, 40 years away?

Pitt-WatsonWe have to make sure we invest in the best possible way to provide an income for the saver’s retirement. Regulators, politicians and the industry need to believe in whichever post-DB system they agree to, and then make it work. And it can: Denmark, for example, moved from 30% of people enrolled in the national scheme up to 90%. Holland has done a terrific job at the macro level, although, of course, it has problems at the micro level.

OerlemansTrue. Liabilities for funds currently exceed their real value, which affects the funding ratio. These problems do matter, but government supervisors and the industry are actively looking for solutions.

CorleyLooking across the channel to the UK, what do you expect from the British NEST?

Pitt-WatsonNEST is a great idea. But it has one hand tied behind its back as it is barred from accepting more than approximately £4,200 per year from any saver and is thus unable to provide comprehensive service to medium-sized and large employers. It might be better for the government to allow qualified low-cost suppliers to compete with NEST as a default provider.

CorleyYou would end up with healthy alternatives rather than a weakened monopoly, though some consistency in design standards is needed. Alwin, what do you suggest to attract lower income groups to saving?

OerlemansAuto-enrollment and transparent communication along with a good default solution are essential. Low costs play an equally significant role, especially for lower income groups, and I would prefer to see vehicles that offer a pension income rather than simply capital, possibly in the form of an annuity.

CorleyHow can we help part-time workers and those with periods of unemployment?

Pitt-WatsonThat is tricky, but the post office might be a good idea. Instead of a private savings account, one would have a private pensions account.

OerlemansDutch part-time workers save a pension depending on their income. People temporarily unemployed do not build up a pension, but the unemployment rate in the Netherlands is around 5%. Self-employed, so-called independents, without personnel, might be a more serious issue as they are not obliged to save. Yet, we are currently discussing possibilities to help them create collective solutions.

CorleyGentlemen, it was a pleasure.

Published by PROJECT M in January 2011 in New Perspectives

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