The Only Way is Up? Britain's challenge to raise pension contribution rates
The Only Way is Up? Britain’schallenge to raise pensioncontribution ratesWednesday June 12th, 2013!Twitter:#onlywayisup!
! Professor David Blake, Cass Business School!! Richard Wilson, Senior Advisor, NAPF!! James Lloyd, Director, Strategic Society Centre!! Dr. Yvonne Braun, Head of Savings andRetirement, Association of British Insurers!! Adrian Richards, Deputy Director – Pensions andAgeing, Department for Work and Pensions!! Chair: Norma Cohen, DemographyCorrespondent, Financial Times. !!
1The Only Way is Up?Britain’s challenge to raise pensioncontribution rates Professor David BlakeDirectorPensions InstituteCass Business Schoold.firstname.lastname@example.org June 2013
2What is the problem that needsaddressing? Ratio of time in retirement to time in work isincreasing This is due to: Increased life expectancy and longevity risk Shorter and more discontinuous working lives Later starts due to higher education Work breaks either voluntary or involuntary:• Unemployment• Child or elderly parent care
3What is longevity risk? We systematically underestimate how longpeople are going to live: Longevity is a slowly-developing trend risk Danger of individuals outliving their savings A related issue is possible long-term care needs
4Official agencies underestimate increasing LEsActual and projected period life expectancy at birth,UK males, 1966-2031Shaw (2007, page 16)
5Individual underestimates of life expectancy by ageSource: O’Brian, Fenn, and Diacon, 2005, self-estimated life expectancy compared with GADforecast life expectancyNumber of years by which consumers underestimate life expectancyWomenMen60-6950-5940-4930-3920-290 2 64 8 10Age
6Source: 100% PNMA00 medium cohort 2007Age25%25%Lifeexpectancy =86.6Most likelyageat death =90%deathsateachageRandom VariationRiskRandom Variation Risk01234565 70 75 80 85 90 95 100 105 110Expected distribution of deaths: male 65!Idiosyncratic risk%deathsateachageExpected distribution of deaths: male 85Lifeexpectancy =91.6Most likely ageat death = 8601234567891085 90 95 100 105Age1 in 3 will reach93 and 5% willreach 100Poor understanding of variability in lifeexpectancyIdiosyncratic risk
7Life expectancy in England and Walesat age 65:By social class and gender, 2002-5Class description males femalesNon-manualI Professional 18.3 22.0II Managerial andtechnical/Intermediate18.0 21.0IIIN Skilled non-manual 17.4 19.9ManualIIIM Skilled manual 16.3 18.7IV Partly skilled 15.7 18.9V Unskilled 14.1 17.7All 16.6 19.4
8What awaits future generations:Longevity fan chart for 65-year old males(CBD model)
9What are the potential consequences? There might be an undesirable fall in standard ofliving in retirement for individuals: Leading an increase in means-tested benefits If this happens for a large number of people,then there will be a large increase in the tax billfor the next generation of employees
10What needs to be recognised? People need to: Determine their desired standard of living inretirement Estimate their life expectancy once retired These factors determine the size of the pensionpot needed to support this standard of living overthe estimated retirement period
11How can the problem be solved? Suppose that this analysis leads to the resultthat the pension pot will not be large enough Only two real solutions: Save more while in work Work longer A third solution is to take more investment risk,but the outcome is unreliable So the real trade-off is between contributingmore and working longer
12What else needs to be taken intoaccount? But DC plans favour those whose lifetime careerearnings peak earliest: Manual workers Women Rather than Professional Managerial workers Because of compounding, the relative size oftheir pension pots will be higher
13What else needs to be taken intoaccount? DC plans will lead to lower pensions for thosewith higher life expectancies Due to post-code annuity pricing The exception is women Under gender equality legislation Those with shortened life expectancies can buyenhanced annuities As a result of health impairments or lifestylechoices Future generations will be worse off due to theirgreater life expectancy
Contribution rate required for a male aged 25 toachieve a 50% replacement ratio by the following ages14Age60 65 70Conservative1investment1strategy1(25%1equities)Ignoring1longevity1risk 26% 16% 8%Allowing1for1longevity1risk 33% 20% 11%Aggressive1investment1strategy1(75%1equities)Ignoring1longevity1risk 23% 13% 6%Allowing1for1longevity1risk 28% 16% 9%
15 There is an unavoidable trade-off between thecontribution rate into a pension plan and age ofretirement Anyone who does not accept that is expectingthe next generation to bail them out If everyone behaves in this way, it is a recipe forintergenerational conflict It’s the demographics stupid!Conclusion
16Thank you!Longevity 9:Ninth International Longevity Risk andCapital Markets Solutions Conference6-7 September 2013Beijinghttp://www.cass.city.ac.uk/longevity-9
James Lloyd, Director, StrategicSociety Centre!
The Only Way is Up? Britain’s challenge toraise contribution rates! Achieving adequate pension income across retiredcohort has two components:!! Adequate participation rates!! Adequate contribution rates!! Current reforms focused on adequate participationrates!! “AE is the easy bit”!! Builds on those employers with good schemes!! But, 8% of qualiﬁed earnings benchmark contributionrate was never expected to be enough!! And looks increasingly inadequate.!
What are the potential approachesfor lifting contribution rates such asregulation, education, incentivesand behavioural interventions?
Whose contribution rates?! Employees!! Employers!! Policy choices around whose contributionrates to push up, and when!
Whose contribution rates?! Employees!! Universal or targeted approach to raisingemployee contributions? !! If targeted, then:!! Who is the priority for intervention?!! Whose contribution rates will be easiest to lift?!! What are the trade-offs of a universal vs.targeted approach?!
Whose contribution rates?! Employees!! Target employees by:!! Age, life-stage!! Tenure!! Region!! Gender!! Sector/employer-type!! Earnings!! Different policy levers appropriate to differentgroups!! And different contribution rates appropriate.!
What are the policy leversavailable?! AE regulation!! Education and information!! Incentives!! Other nudges!!
AE regulation! Raise the 8% of qualifying earningsbenchmark total contribution rate inlegislation through higher employeecontributions!! From current ‘ﬂoor’ to higher level!! E.g. median adequate rate!! But what is median adequate rate for workforce?!! And, lifting employee benchmark contributions willinevitably increase opt-out rates!! Where is the ‘top of the curve’?!!
Education and information! Tell people what they should be contributing!! Again – trade-off between universal vs. nuanced,targeted information!! Questions over effectiveness!! Everyone knows they should be saving more!! Not everyone knows what percentage of incomethey are contributing!! How effective is education at getting people totake action?!!
Incentives! Link incentives to save to proportion of earnings put inpension!! Two key levers: employer contribution, tax-relief!! Review interaction with different levels of employeecontribution!! But penalty for those under greater ﬁnancial pressure, e.g.parents?!! Alternatively, look at rules/treatment of different shareof savings: !! First x% of employee contribution treated differently tosecond x%?!! E.g. only the second x% of employee contribution can betaken as 25% lump-sum?!!
Other nudges! Apply other behavioural economicstechniques besides AE (default) !! ‘Commitment’: “Save more tomorrow”!! Pre-agreed commitment to increase proportion ofincome saved at time of next pay-rise.!! ‘Norms’: use inﬂuence of what others aredoing!! “The average contribution rate by employees inyour organisation/sector/age-group is x%”!!
1The only way is up?• Adequacy varies by individual• Govt as an enabler• Contributions play a critical role in retirement income• Impact of reform will take time to work through• Auto-escalation looks promising• Wider points
! What exactly is an adequate pension contribution rate? Howdoes it vary by earnings, life stage, preferences, cohort andtrends in economic growth?!! Should policymakers aim for a universal, benchmarkcontribution rate or opt for a more individualized approach?!! What are the potential approaches for lifting contribution ratessuch as regulation, education, incentives and behaviouralinterventions?!! What should be the balance between boosting employer andemployee contribution rates?!! What do long-term economic and mortality trends mean fordeﬁning an adequate contribution rate for the workforce?Could this eventually be beyond what workers will voluntarilyaccept?!! Is the UK economy and Exchequer ready for high levels ofparticipation and contribution rates across the workforce? Ifnot now, when?!
!!!!Strategic Society Centre 32-36 Loman Street London SE1 0EH email@example.com!www.strategicsociety.org.uk Twitter: @sscthinktank !!The Strategic Society Centre is a registered charity (No. 1144565)incorporated with limited liability in England and Wales (Company No.7273418).!