Public pension reform has taken much of the glitter off the golden years of retirement. But do these reforms affect saving behavior? “Absolutely,” says Rob Alessie, professor for microeconometrics at the University of Groningen (Netherlands). “The good news is that the uncertainty in the retirement world leads people to save more. The bad news is they do not save enough.”
The sample data for Pension Wealth and Household Saving in Europe stems from the third wave of the “Survey of Health, Ageing and Retirement in Europe,” known as Sharelife. Conducted in 13 European countries, Sharelife provides retrospective information on life histories. It records participants’ job histories, wages earned, childhood health, relationships and housing which can be linked to data on household wealth, expected replacement rate and retirement age collected in the survey’s previous waves.
Alessie and colleagues analyzed key social, economic and health events of 3590 Europeans (age 55 to 75) over their entire life (
Pension Wealth and Household Saving in Europe). Based on retrospective information about lifetime earnings, linked to household wealth, expected replacement rate and retirement age, the researchers made one observation per individual per year, from birth until 2009 (see Methodology).
Calculating the subjects’ pension wealth, past and, where relevant, future labor income, Alessie found that “Europeans only compensate for 40-60% of the decrease they will encounter in first and second pillar pension income. This can be explained by several phenomena such as lack of financial literacy, procrastination behavior and credit constraints. It is difficult to say which is most important but my feeling is that lack of financial literacy is a serious problem,” says Alessie.
The results shed light on the impact of pension reforms in Europe, Alessie and colleagues write. “European households will react to reductions in pensions by increasing private savings, although not strong enough to smooth consumption over the life cycle.”
Understanding the gap is an important step towards the ideal retirement nest egg. “One has to keep in mind that the underlying model omits aspects of real life such as credit constraint or career uncertainties, but the results indeed suggest that if let off the hook of mandatory contributions, Europeans choose to save less,” says Tobias Klein, associate professor at Tilburg University and a member of the European pension research network Netspar.
With the glitter taken off the golden years, we now need to understand how people make decisions and what they really want as retirement income.
To increase saving rates, Alessie recommends financial education. “Government policy should focus on the less-educated and perhaps financially illiterate households, although providing more information does not necessarily improve savings behavior.”
It might even be irrelevant. The current policy based on information and financial education is unlikely to help people make the required pension choices, Henriette Prast (Tilburg University) writes in a
paper to be published this fall (Prast and her co-authors conclude that “information by itself does not do much when it comes to saving for retirement.”
Their findings are corroborated by previous research. Nobel Memorial Prize winner Robert C. Merton warns that life-cycle saving and investing decisions are too complex for laymen. In
a 2005 paper , James J. Choi, David Laibson, and Brigitte C. Madrian point out that the publicity around retirement savings wiped out by the collapses of US companies Enron, WorldCom and Global Crossing did little to change US savers’ behavior. “Real-life lessons about underdiversification risks do not seem to translate well into action,” they state.
Aware of this discussion, Alessie adds consumer protection measures and mandatory saving to the pension reform list of ingredients. Defaults, mandated choice, commitment mechanisms and relevant information such as images of an aged self are also Prast’s preferred policy instruments to prod savers into action.
Yet, where exactly the action should lead to still needs to be understood.