Engagement is no solution to the savings crisis
As part of ICAS’ Challenging Conversations on pensions, Gregg McClymont critiques the industry’s overwhelming focus on ‘engagement’ as the means to drive more efficient pensions outcomes for savers.
Adequacy, coverage, cost. These are the parameters by which a pension system is judged. Do pensioners have enough income to live a decent life? Are enough members of the working population regularly contributing? What is the financial cost of the system and is it sustainable?
Engagement is, by its very nature, more subjective. Measuring its impact on outcomes even more so. Nonetheless it’s hard to attend a pensions industry gathering in the UK without “engagement” emerging as a crucial facet of value for member (VfM).
Long-term saving behaviour prevents engagement in pensions
Engagement with pensions is low when compared to most other goods and services.
Markets work most efficiently when active and engaged consumers make rational purchasing decisions about goods and services based on price and quality. Thus the extraordinary increase in the quality and extraordinary decrease in the cost of, say, consumer electronic goods whether TVs, mobiles, laptops, or cameras.
A vast behavioural science literature exists on our approach to long-term saving.
Wouldn’t it be great if pensions were like that? Sure would.
Alas the peculiar nature of the product makes that unlikely. First, the value of one pensions product versus another is hard to measure at a fixed moment in time given the volatility of investment returns.
Second, sellers of pensions almost always understand what’s underneath the bonnet far better than buyers.
Third, a vast behavioural science literature now exists, devoted to illuminating the inertia, mistaken assumptions, and wishful thinking which characterises our (mine and yours) approach to long-term saving.
Richard Thaler just won the Nobel Prize for this stuff. ‘Bounded rationality’ in the jargon reflected in present bias, loss aversion, confirmation bias, decision fatigue, and so on. To say nothing of our general desire not to think about getting old (and dying), which thinking about our pension arrangements inevitably conjures up.
The Swedish example: successful engagement is very expensive and doesn’t mean better outcomes
Thaler’s recent study of the Swedish Premium Pension system’s attempts to persuade people to make an active choice of investment fund is striking. By deploying huge “one off” resources to drive engagement, a pension system can persuade individuals to make choices. But never again, to the detriment of those whose original choice of fund proved a poor (and even a fraudulent) one.
An interesting piece of research in the wake of Sweden’s pensions experiment suggests that engagement worsens outcomes for one group (those who mistakenly believe they are financially literate) and is neutral for the others (those who are already financially literate and those who know they are not).
Note that in the UK levels of financial literacy are terribly low.
Engagement is not a panacea
If this sounds like a counsel of despair, it’s not meant to be. It’s a plea for more clarity about what we mean by engagement with pensions and greater modesty about what such engagement is likely to achieve with a recognition of potentially negative as well as positive outcomes.
The world’s most effective pension systems - Denmark, Netherlands, Sweden, Australia - don’t depend on engagement to make their systems world class.
So, a simplified annual pension statement will be a good thing. So too, a single pensions dashboard which virtually aggregates an individual’s pension entitlements for the first time. Also, the digitalising of the relationship between individuals and their pension provider as a means of enabling more frictionless decision making.
Good customer service demands the availability of all three innovations and indeed some of the world’s most effective pension systems (Denmark, Netherlands, Sweden, Australia) offer this experience, for those willing or able to take active decisions.
But these systems don’t depend on engagement to make their systems world class. Large pension funds governed solely in the interests of members to, and through, retirement do that job. A lesson indeed, for the UK. Time to thumb the pages of the OFT’s 2013 DC market study again.
Key findings from the OFT’s report into DC pensions
In September 2013, The Office of Fair Trading produced its market study of defined contribution workplace pensions.
The aim of the study was to examine if, in the light of automatic enrolment, competition is capable of driving value for money and good outcomes for scheme members.
Here are key summaries from p29 of the report:
1.50 … it would be helpful for future policy and regulatory initiatives to be informed by longer term principles for how the DC workplace pension market should evolve. In our view, these principles would be:
- Scale: there are significant economies of scale in the purchase of administration and investment, and in the governance of pension schemes, that the market should take advantage of. Policies could help accelerate this process and remove barriers to scale while avoiding concentration.
- Alignment of incentives: better alignment of the incentives of employers, trustees, advisers, providers and investment managers with those of scheme members is the best way to ensure that actions are taken in the interest of scheme members. This should be coupled with clear responsibility and accountability for those making choices on behalf of savers. Regulation should promote this alignment and accountability.
- Robust independent governance: Policy should promote robust governance for DC schemes across the market.
- Flexibility: We would expect the DC market to develop products that allow greater flexibility in investment decisions, including products that allow for collective pooling of risk between scheme members.
- Simplicity and switching: in the interests of promoting switching, policy should look to promote simpler products, with transparent charges and to ease the process for employees and trustees of switching between different pension products.