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The OECD’s plans to make pensions popular

The OECD aims to popularise schemes, writes John Greenwood

pablo antolin OECD

The Organisation For Economic Co-operation and Development’s goal of promoting policies that improve the economic and social wellbeing of people around the world is something few would fault. For OECD private pensions unit principal economist Pablo Antolin, that means making sure nations understand they have to get their citizens to retire later while at the same time establishing safe and efficient structures for individuals to save for themselves.

The OECD, whose membership is made up by 34 states, principally in the developed world, says there are two key areas that countries need to address if they are to combat the growing economic burden of changing demographics – later retirement and extending the coverage of private pensions.

The UK’s accelerated increases in state pension age have put us near the top of the class on the first count. And our massive existing private pension sector, soon to be supplemented by auto-enrolment, means the UK is already well placed in many parts of the latter. But that does not mean we do not face significant challenges.

A recent OECD report found the investment returns our savings industry has achieved since the turn of the millennium have been among the worst in the developed world.

The OECD figures show a stark difference in average investment returns between UK schemes and other European countries. Between 2001 and 2010, UK pensions achieved on average an annualised real return of -0.1 per cent a year, compared to Germany’s +3 per cent and Denmark’s +4 per cent.

For Antolin, that does not necessarily mean UK pension fund managers have to ape the conservative investment strategies used by their European counterparts. But it does mean attention needs to be paid to ensuring the pension savers are not exposed to more risk than necessary.

“Why has Germany done better than the UK? What matters is asset allocation. The UK has been on average more into risky assets than Germany. So you look at the last 10 years, when risky assets have done badly, and it is clear that the UK would do worse than Germany,” says Antolin.

“But if you look at a more appropriate period for pension saving, say 40 years, there is not much difference between the two. In the 1980s and 1990s when risky assets were doing well, the UK did better than Germany. For this decade it has been the other way around.”

So, with the UK pensions industry suffering such poor performance just as it is about to automatically enrol 10 million or so workers into its default funds, should the nation stick with its attachment to equities in the hope that they have got to come back eventually?

Perhaps not surprisingly, Antolin is not prepared to say what equity exposure is the ‘right’ one for current market conditions in the UK.

“That is the billion dollar question. What the UK should do is to evaluate whatever portfolio is suitable to it going forward. But for default funds, we do say that you need to have a default for those that are unable or unwilling to choose a strategy that reduces negative shocks that can come with risky assets in the years before retirement.”

Few would disagree with that, although in the UK many legacy pension schemes, some of which will be used as auto-enrolment vehicles, still have a very high exposure to equities.

This issue is just one of the challenges to effective DC schems that the Paris-based organisation is looking to address in a project Antolin is engaged in that looks to standardise international best practice for the construction of private sector pension systems to facilitate compulsion or auto-enrolment.

Antolin says: “In October, we are publishing a book on how to improve the design of DC pension plans. It will have a list of recommendations, approved and endorsed by regulators on how to improve the design of DC plans.

“Defined contribution, private pension plans are increasingly an integral part of most countries’ overall pension system, while for some countries they are the main component of their pension system. Therefore, overall retirement income adequacy depends on the pension benefits stemming from these plans.”

The document, The OECD Roadmap For The Good Design of Pension Plans, which has been agreed by a working party made up of representatives from regulators in member countries, comprises 10 key recommendations. Some are already standard practice in the UK, such as the promotion of low-cost retirement savings vehicles and auto-enrolment.

Other recommendations include factors currently under debate in the UK such as a call for more efficient use of incentives such as tax relief and matching, greater coherence between the accumulation and decumulation periods of DC schemes and a more efficient annuity market.

With regulators signed up to these principles it seems likely they will inform structural changes to the pensions market going forward.

Auto-enrolment UK-style is exactly the sort of thing the OECD wants countries without compulsory private schemes to be implementing and Antolin sees no reason why take-up of auto-enrolment in the UK should not be relatively high, now the state system looks like being fixed to reduce the means-testing issue.

“The only thing you can say is that it does not seem like there are perverse incentives to opt out. Maybe at the beginning there will be more people who opt out, as there were in Sweden when they introduced it, but two years later they had less doing so.”

On the other hand, while the OECD’s 10-point plan calls for a more efficient annuity market, Antolin does not share the same depth of concern at the implementation of the EU gender underwriting ban, due to take place fromDecember 21, 2012 that some UK commentators hold.

He agress the ban on gender underwriting will skew the market, but argues the effect will be limited.

“If buying an annuity is mandatory then it does not matter, because everyone in the pool cancels each other out, so men get less but women get more.”

The OECD’s 10-point strategy for improving private pensions also calls for life-cycle investment strategies for default funds, and although these are already widespread in the UK, Antolin warns against making them too complicated, because most people simply will not understand them.

He says: “If you talk to asset managers they will say they can do a dynamic risk strategy that will do a better job. Maybe, but people will not understand what is going on.”

Addressing financial literacy and lack of awareness of individuals’ own personal pensions gap is another objective on the OECD’s agenda. So what does Antolin think of the proposal put forward by IBM for the creation of a citizen’s pensions portal that would collate details of all an individual’s pension savings into a single webpage?

“Something like this has already worked successfully in several Scandinavian countries, and also in Chile,” says Antolin. “It is not a panacea, because in reality most people do not look at it, but creating one does mean people do have a source of information to look at how much they have if they want to.”

However, he warns against over-complicating any such system.

“The key with a portal like this is how do you design it. What sort of language do you use, and what your objective is. If it attempts to achieve 20 different objectives then it will be complicated and people will not use it.

“One objective we suggest as being useful is not just to let people know how much they have, but also to make that knowledge productive, so they can understand that if they pay a put more or work a bit longer, the chances of having a decent retirement income are that much higher.”

IBM is ultimately considering a portal that could facilitate transfers between schemes, but Antolin advises against creating something that tries to do too much at the same time.

“Now you are talking about something completely different. Now you are saying we should have a portal in which fees are disclosed. This does not have anything to do with pension statements. Having a portal in which costs can be clearly seen is complicated because different strategies have different charges. You complicate the portal if you add this in as well. But you could have an entrance portal that only has the statement, and from there be directed to another portal that deals with charges and potential transfers.”

Other items in Antolin’s in-box include work being carried out with Dr David Blake at Cass Business School on assessing pension funds’ and annuity providers’ exposure to longevity risk.

With Solvency II less than 18 months away and defined benefit schemes concerned at their potential new solvency rules, the paper is a timely one. And with October’s launch of the Roadmap For The Good Design of Pension Plans coinciding with the dawn of UK auto-enrolment, those responsible for this country’s workplace schemes can expect plenty of food for thought.

Pablo Antolin CV

Principal economist at the private pension unit of the OECD Financial Affairs Division. Currently working on four projects: annuities and the payout phase; the impact of longevity risk and other risks, the design of investment strategies for default funds in defined contribution pension plans and a joint project with the World Bank on comparing the financial performance of private pension funds across countries.

Worked at the IMF and at the OECD Economic Department. Has published journal articles on ageing issues as well as labour market issues.

PhD in economics from the University of Oxford and a degree in economics from the University of Alicante, Spain.

The OECD Roadmap For The Good Design Of Pension Plans

1. Ensure the design of DC pension plans is internally coherent between the accumulation and payout phases and with the overall pension system.

2. Encourage people to enrol, to contribute and contribute for long periods.

3. Improve the design of incentives to save for retirement, particularly where participation and contributions to DC pension plans are voluntary.

4. Promote low-cost retirement savings instruments.

5. Establish appropriate default investment strategies, while also providing choice between investment options with different risk profile and investment horizon.

6. Consider establishing default life-cycle investment strategies as a default option to protect people close to retirement against extreme negative outcomes.

7. For the payout phase, encourage annuitisation as a protection against longevity risk.

8. Promote the supply of annuities and cost-efficient competition in the annuity market.

9. Develop appropriate information and risk-hedging instruments to facilitate dealing with longevity risk.

10. Ensure effective communication and address financial illiteracy and lack of awareness.


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