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The Only Way is Up? Britain's challenge to raise pension contribution rates

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The Only Way is Up? Britain’s
challenge to raise pension
contribution rates
Wednesday 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 and
Retirement, Association of British Insurers!
!  Adrian Richards, Deputy Director – Pensions and
Ageing, Department for Work and Pensions!
!  Chair: Norma Cohen, Demography
Correspondent, Financial Times. !
!
1
The Only Way is Up?
Britain’s challenge to raise pension
contribution rates
 
Professor David Blake
Director
Pensions Institute
Cass Business School
d.blake@city.ac.uk
12 June 2013
2
What is the problem that needs
addressing?
  Ratio of time in retirement to time in work is
increasing
  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
3
What is longevity risk?
  We systematically underestimate how long
people 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
4
Official agencies underestimate increasing LEs
Actual and projected period life expectancy at birth,
UK males, 1966-2031
Shaw (2007, page 16)

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The Only Way is Up? Britain's challenge to raise pension contribution rates

  • 1. The Only Way is Up? Britain’s challenge to raise pension contribution rates Wednesday June 12th, 2013! Twitter: #onlywayisup!
  • 2. !  Professor David Blake, Cass Business School! !  Richard Wilson, Senior Advisor, NAPF! !  James Lloyd, Director, Strategic Society Centre! !  Dr. Yvonne Braun, Head of Savings and Retirement, Association of British Insurers! !  Adrian Richards, Deputy Director – Pensions and Ageing, Department for Work and Pensions! !  Chair: Norma Cohen, Demography Correspondent, Financial Times. ! !
  • 3. 1 The Only Way is Up? Britain’s challenge to raise pension contribution rates   Professor David Blake Director Pensions Institute Cass Business School d.blake@city.ac.uk 12 June 2013
  • 4. 2 What is the problem that needs addressing?   Ratio of time in retirement to time in work is increasing   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
  • 5. 3 What is longevity risk?   We systematically underestimate how long people 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
  • 6. 4 Official agencies underestimate increasing LEs Actual and projected period life expectancy at birth, UK males, 1966-2031 Shaw (2007, page 16)
  • 7. 5 Individual underestimates of life expectancy by age Source: O’Brian, Fenn, and Diacon, 2005, self-estimated life expectancy compared with GAD forecast life expectancy Number of years by which consumers underestimate life expectancy Women Men60-69 50-59 40-49 30-39 20-29 0 2 64 8 10 Age
  • 8. 6 Source: 100% PNMA00 medium cohort 2007 Age 25% 25% Life expectancy = 86.6 Most likely age at death = 90 %deathsateachage Random Variation Risk Random Variation Risk 0 1 2 3 4 5 65 70 75 80 85 90 95 100 105 110 Expected distribution of deaths: male 65! Idiosyncratic risk %deathsateachage Expected distribution of deaths: male 85 Life expectancy = 91.6 Most likely age at death = 86 0 1 2 3 4 5 6 7 8 9 10 85 90 95 100 105 Age 1 in 3 will reach 93 and 5% will reach 100 Poor understanding of variability in life expectancy Idiosyncratic risk
  • 9. 7 Life expectancy in England and Wales at age 65: By social class and gender, 2002-5 Class description males females Non-manual I Professional 18.3 22.0 II Managerial and technical/Intermediate 18.0 21.0 IIIN Skilled non-manual 17.4 19.9 Manual IIIM Skilled manual 16.3 18.7 IV Partly skilled 15.7 18.9 V Unskilled 14.1 17.7 All 16.6 19.4
  • 10. 8 What awaits future generations: Longevity fan chart for 65-year old males (CBD model)
  • 11. 9 What are the potential consequences?   There might be an undesirable fall in standard of living 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 bill for the next generation of employees
  • 12. 10 What needs to be recognised?   People need to:   Determine their desired standard of living in retirement   Estimate their life expectancy once retired   These factors determine the size of the pension pot needed to support this standard of living over the estimated retirement period
  • 13. 11 How can the problem be solved?   Suppose that this analysis leads to the result that 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 contributing more and working longer
  • 14. 12 What else needs to be taken into account?   But DC plans favour those whose lifetime career earnings peak earliest:   Manual workers   Women   Rather than   Professional   Managerial workers   Because of compounding, the relative size of their pension pots will be higher
  • 15. 13 What else needs to be taken into account?   DC plans will lead to lower pensions for those with higher life expectancies   Due to post-code annuity pricing   The exception is women   Under gender equality legislation   Those with shortened life expectancies can buy enhanced annuities   As a result of health impairments or lifestyle choices   Future generations will be worse off due to their greater life expectancy
  • 16. Contribution rate required for a male aged 25 to achieve a 50% replacement ratio by the following ages 14 Age 60 65 70 Conservative1investment1strategy1(25%1equities) Ignoring1longevity1risk 26% 16% 8% Allowing1for1longevity1risk 33% 20% 11% Aggressive1investment1strategy1(75%1equities) Ignoring1longevity1risk 23% 13% 6% Allowing1for1longevity1risk 28% 16% 9%
  • 17. 15   There is an unavoidable trade-off between the contribution rate into a pension plan and age of retirement   Anyone who does not accept that is expecting the next generation to bail them out   If everyone behaves in this way, it is a recipe for intergenerational conflict   It’s the demographics stupid! Conclusion
  • 18. 16 Thank you! Longevity 9: Ninth International Longevity Risk and Capital Markets Solutions Conference 6-7 September 2013 Beijing http://www.cass.city.ac.uk/longevity-9
  • 22. James Lloyd, Director, Strategic Society Centre!
  • 23. The Only Way is Up? Britain’s challenge to raise contribution rates !  Achieving adequate pension income across retired cohort has two components:! !  Adequate participation rates! !  Adequate contribution rates! !  Current reforms focused on adequate participation rates! !  “AE is the easy bit”! !  Builds on those employers with good schemes! !  But, 8% of qualified earnings benchmark contribution rate was never expected to be enough! !  And looks increasingly inadequate.!
  • 24. What are the potential approaches for lifting contribution rates such as regulation, education, incentives and behavioural interventions?
  • 25. Whose contribution rates? !  Employees! !  Employers! !  Policy choices around whose contribution rates to push up, and when!
  • 26. Whose contribution rates? !  Employees! !  Universal or targeted approach to raising employee 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?!
  • 27. Whose contribution rates? !  Employees! !  Target employees by:! !  Age, life-stage! !  Tenure! !  Region! !  Gender! !  Sector/employer-type! !  Earnings! !  Different policy levers appropriate to different groups! !  And different contribution rates appropriate.!
  • 28. What are the policy levers available? !  AE regulation! !  Education and information! !  Incentives! !  Other nudges! !
  • 29. AE regulation !  Raise the 8% of qualifying earnings benchmark total contribution rate in legislation through higher employee contributions! !  From current ‘floor’ to higher level! !  E.g. median adequate rate! !  But what is median adequate rate for workforce?! !  And, lifting employee benchmark contributions will inevitably increase opt-out rates! !  Where is the ‘top of the curve’?! !
  • 30. 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 income they are contributing! !  How effective is education at getting people to take action?! !
  • 31. Incentives !  Link incentives to save to proportion of earnings put in pension! !  Two key levers: employer contribution, tax-relief! !  Review interaction with different levels of employee contribution! !  But penalty for those under greater financial pressure, e.g. parents?! !  Alternatively, look at rules/treatment of different share of savings: ! !  First x% of employee contribution treated differently to second x%?! !  E.g. only the second x% of employee contribution can be taken as 25% lump-sum?! !
  • 32. Other nudges !  Apply other behavioural economics techniques besides AE (default) ! !  ‘Commitment’: “Save more tomorrow”! !  Pre-agreed commitment to increase proportion of income saved at time of next pay-rise.! !  ‘Norms’: use influence of what others are doing! !  “The average contribution rate by employees in your organisation/sector/age-group is x%”! !
  • 33. 1 The 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
  • 34. !  What exactly is an adequate pension contribution rate? How does it vary by earnings, life stage, preferences, cohort and trends in economic growth?! !  Should policymakers aim for a universal, benchmark contribution rate or opt for a more individualized approach?! !  What are the potential approaches for lifting contribution rates such as regulation, education, incentives and behavioural interventions?! !  What should be the balance between boosting employer and employee contribution rates?! !  What do long-term economic and mortality trends mean for defining an adequate contribution rate for the workforce? Could this eventually be beyond what workers will voluntarily accept?! !  Is the UK economy and Exchequer ready for high levels of participation and contribution rates across the workforce? If not now, when?!
  • 35. ! ! ! ! Strategic Society Centre
 32-36 Loman Street
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 info@strategicsociety.org.uk! 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).!