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Overprotecting the public

Regulatory authorities are there to protect consumers. But is the strong swing back to their overseeing pension solutions in the public interest?

Daniel Sandmann and Greg Langley

It has been often noted by industry commentators that retirement savers have in recent decades been left out in the rain. For more than a decade, governments have pruned public benefits and placed emphasis on occupational pensions to sustain individuals throughout retirement. For their part, employers, faced with underfunded defined benefit (DB) schemes and the unexpected longevity of former employees, have been shifting to defined contribution (DC) schemes to limit their liabilities, which is changing the risk distribution between the pensions provider and the customer. While DB schemes guarantee retirees a defined payment per month in retirement, under DC schemes little is guaranteed – except that individuals are left alone to weather all investment, inflation and longevity risks.

On the life insurance side, years of persistent near zero interest rates mean solid returns can no longer be guaranteed. In place of traditional savings products, hybrids now combine capital opportunities and safety mechanisms, but with low or no return guarantees. Such products can provide a significant return to the customer, but represent a new breed of vehicles with a different set of risks than in the past.

A CHANGE IN PRACTICE?

These developments have resulted in a dramatically different retirement savings environment. Far more is demanded of savers today even though financial literacy studies show most people do not have the skills to make sophisticated long-term investment decisions. The industry and customers need to access – with a time horizon of 50–60 years – the expected exposure to financial market risks such as return volatility, the effects of inflation and the dangers of outliving one’s assets. Any misstep could mean the saver will not only face falling living standards in retirement, but straight-out poverty.

Zvi Bodie, a professor from Boston University, says this is a fallacy of the current system and summarized it best when he said it is like telling people, “Health insurance no longer covers surgery, so you’ll have to do it yourself after reading this brochure.”

This situation is driving a decided swing back towards the state again offering shelter to retirement savers. The most recent example is NEST in the UK, the DC pension scheme set up to automatically enroll workers as part of workplace pension reforms. In Germany, there is discussion of a “Nahles-Rente,” proposed reforms named after Andrea Nahles, the Federal Minister of Labor and Social Affairs, which is something of a cut-and-paste of NEST.

Health insurance no longer covers surgery, so you’ll have to do it yourself after reading this brochure Zvi Bodie

Yet the most ambitious project is the effort of the European Insurance and Occupational Pensions Authority (EIOPA) to create standardized, private Pan-European Pension Products (PEPPs). A cross-border approach makes sense if it increases the workers’ mobility in Europe and helps providers achieve scale and improve competitiveness to create better returns and lower costs for pension savers. PEPPs, however, as a product group are shaped by regulation. The role of the industry is yet to be defined. How will insurers and asset managers be involved? Will syndication be relevant?

These are critical questions whose answers will be highly contentious within one or more of the distinct national retirement provision policies of the European Union. Yet the most striking aspect of the PEPPs approach is that it marks a decided change in practice. In the past, the industry would create products and regulators focused on the prudential risks coming with these product solutions. Now, the public side are effectively saying, “This time we’ll do it ourselves.”

Regulatory authorities should protect consumers, and it is undeniable, given the complexity of the financial decisions and products the public faces, that they do need protection. But is such a strong swing back to the state’s overseeing solutions in the public interest?

In the case of PEPPs, given that it would require far-reaching legal harmonization, regulators need to lead the way. However, while any initiative to encourage people to save for retirement is to be applauded, it is presumptuous to assume one particular “best” approach can meet the needs of all citizens.

This is particularly pertinent for such a strange beast as the European Union composed, as it still is, of 28 different states each with a market of different and often competing participants and interests. Many of these pension markets are already overburdened by regulation. This can result in subsidies provided to encourage savers absorbed by providers themselves, as providers seek to defray the complex costs of regulatory compliance.

With PEPPs, the risk is that the EU will not so much create consumer confidence in Pan-European Pension Products by putting in place legislation to protect savers, as be imposing yet another layer of regulatory requirements. If this is the result, individual markets will experience pain as they try to lay these regulations over existing national regulatory environments.

SMOTHERED WITH PROTECTION

Ultimately, this will not be in the interest of pension savers. Today, there are already a confusing array of retirement saving options available, so if PEPPs result in increased complexity savers are likely to avoid or underinvest in such products. A better approach to encourage retirement savings at the European level would be through income tax deferrals and a wide choice of underlying investment products with transparent expenses.

Where savers need assistance is in the form of protection and advice to understand their options through more guidance and advice. Only if industry gets it right and offers transparent and fair products, will the incentives for state-operated solutions cease. After years of pushing savers outside to look after themselves, regulators now risk overcompensating by smothering them with protection and preventing them from saving enough to support themselves in retirement.

Overprotecting the public

Regulatory authorities are there to protect consumers. But is the strong swing back to their overseeing pension solutions in the public interest?

Daniel Sandmann and Greg Langley

Overprotecting the public

Regulatory authorities are there to protect consumers. But is the strong swing back to their overseeing pension solutions in the public interest?

Daniel Sandmann and Greg Langley

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