The Only Way is Up? Britain's challenge to raise pension contribution rates
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This document summarizes a discussion on raising pension contribution rates in the UK. It discusses how longevity has increased the ratio of time spent in retirement to time spent working. To achieve adequate retirement incomes, both high participation rates in pensions as well as adequate contribution rates are needed. Currently, reforms have focused on participation rates, but contribution rates of 8% of earnings may not be enough. Raising contribution rates could involve increasing regulations on minimum contributions, improving education, using incentives, or nudges like automatically increasing contribution rates over time. Both employee and employer contribution rates may need to increase, but this requires balancing adequacy with preventing increased opt-outs.
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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
- 20. PQM$contribu-on$levels$ Employer) contribu0on) Total) contribu0on) Pensionable)pay) AE)minimum) 3%) 8%) Band)earnings) (£6k)@)£41k)) PQM) 6%) 10%) Basic)pay) PQM)PLUS) 10%) 15%) Basic)pay)
- 21. Annual$amounts$for$average$earner$ Employer) contribu0on) Total) contribu0on) Pot)aKer)40) years)saving) AE)minimum) £600) £1,600) £103,000) PQM) £1,600) £2,600) £167,000) PQM)PLUS) £2,600) £3,900) £251,000)
- 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 London SE1 0EH 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).!