Following the financial crisis, many countries realized their pension systems were ill-equipped to handle participants’ retirement needs. In a white paper released Friday, “Building a Better Retirement World,” EY identifies seven ways policymakers and pension plan providers can improve their current systems.
Ensuring local pension systems are as healthy as possible is a global concern due to the “global connectivity of investment markets and economies,” according to the report.
There are five components of a healthy pension system: financial adequacy, sustainability, performance, efficiency and effectiveness and political aspects.
“There is no single response to appropriate policy reform as systems operate in different socioeconomic and political contexts and levels of maturity,” EY acknowledges in the report. “However, learning from other systems and peers increases the accuracy of root cause analysis, improves understanding of the need for tough decisions and provides a political perspective on possible long-term solutions.”
EY conducted over 80 interviews with policymakers, regulators and pension executives in 18 countries for the report. Here are its seven recommendations for improving pension systems:
The paper claims pension systems in developed markets have an expectations problem: increasing longevity and high expectations for retirement outcomes aren’t in line with available financial resources. The financial crisis hit public and private pensions hard, and they haven’t recovered.
The paper argues that continued lack of action could lead to another crisis, as retirement shortfalls lead to increasing old-age poverty.
Common responses to those challenges include the shift to defined contribution plans, along with increases in automatic enrollment programs, increases in the retirement age, and limiting automatic benefit increases in pensions.
EY found that especially in emerging market systems, assets are increasing faster than local capital markets are developing. “This strains national financial systems in terms of operational risk, regulatory oversight, liquidity and infrastructure, and may impact sound pension and retirement system growth in local markets,” according to the report.
There are three key areas that need attention:
- Investment home bias creates concentration risk and increases volatility, according to the report, and limits the sophistication of market instruments.
- Some countries offer multiple retirement benefits, like housing assistance or social security programs, which create more complexity and confusion among consumers.
- Savings “culture” and financial literacy are not as well-developed in some countries, leading to lower participation. Making financial literacy a priority may improve contributions and trust.
The sheer size of pension markets and the consequences of them failing “demand an entirely new level of political and public attention,” according to EY. In Australia, private pension fund assets were 92% of GDP in 2012; in the U.K., assets were 96%, according to the OECD. In Switzerland and the Netherlands, they were over 100% of GDP (114% and 160%, respectively).
Some systems have improved their governance following the financial crisis, according to the report, but others, especially less sophisticated systems, have yet to advance beyond a compliance platform. “This poses significant strategic and operational risks; i.e., current practices are not aligned to ballooning assets, and pension and retirement entitlements are rising.”
Pension providers need to keep a close eye on “operational excellence,” according to the report, and improve service delivery and customer experience, while also keeping costs low. Considering the number of transactions that take place in a retirement plan — collecting and allocating contributions, maintaining records, submitting statements, paying benefits — automation and reducing exceptions are the two primary ways of sustainably keeping costs low.
Providers are also choosing products not just on their cost, but on what they offer participants: features and outcomes, experience, delivery and flexibility.
Transparency is another issue, as limited transparency in many systems makes it difficult for consumers to compare their plan with another.
“Future reform must drive operational excellence to the next level,” according to EY. “Leveraging existing experience and infrastructure from other mass transaction industries, such as banking or securities processing, can add significant value to improve efficiency and effectiveness, resulting in beneficial retirement outcomes.”
The financial crisis exposed problems in some providers’ investment strategies, according to the report. In particular, risk management was shown to be less stringent than it should have been.
The respondents interviewed by EY suggested policymakers and providers align risk management with the current size and complexity of the system, and prepare for future increases in assets and liabilities.
Complicated government and social programs, complicated products and regulatory protections, not to mention myriad tax incentives and restrictions, make it difficult for consumers to buy in to the plan. EY suggests creating a new role, “chief simplicity officer,” to focus on the changes necessary to drive participant engagement.
Consumers are more engaged overall, EY argued, suggesting policymakers and pension providers should focus on the customer, using their “language, how and when they want it.”
Respondents offered three elements of an effective refocus on consumer needs.
- Strategy: Providers need to understand participants’ needs and behaviors and make them their priority in decision making.
- Experience: Between participants’ accumulation and distribution phases, the relationship with their plan lasts many years and it can be difficult to provide high-quality service consistently over that time period.
- Communication: Though respondents agreed communication was important, there was less consensus about the ideal level of engagement and how much should be invested in reaching that level.
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