This is one of the key recommendations made by the OECD in respect of the growing number of asset backed pension arrangements (“funded pensions”), which are contributing to the diversification of sources used to finance retirement and complementing pay-as-you-go (PAYG) public pensions. Diversification and complementarity are two of the long-standing OECD policy recommendations for good pension design.
The report shows that assets in funded pensions represented more than 50% of GDP in ten OECD countries in the early 2000s, increasing to 13 countries by the end of 2015. The number of countries where assets in funded private pension arrangements represent more than 100% of GDP has increased from four to seven OECD countries over the last 15 years.
The increased role of funded pension arrangements mostly comes from defined contribution (DC), pension arrangements in which there is a direct link between contributions, assets accumulated and pension benefits. However, the OECD warns that although these arrangements have important advantages, they put more of the risks of saving for retirement (e.g. investment and longevity risk) and decision making on the hands of individuals.
Overall, pension systems are changing and are adjusting to the challenges they face. These include ageing populations, the fallout from the financial and economic crisis, and the current environment of low economic growth and low returns.
As pension systems respond to them the pension landscape continues to evolve.
Pablo Antolin, Principal Economist and Head of the Private Pension Unit, commented: “DC pensions are becoming increasingly prominent and are here to stay. In the current environment of population ageing, low growth and low interest rates, they have useful features. However, as individuals bear more risks and responsibility for managing their retirement finances, we need to focus on improving and simplifying their design to assist them in doing so.
“To alleviate the pressure on individuals, the OECD advocates the use of financial advice and partial annuitisation which transfers the responsibility for managing longevity risk from individuals to professionals such as insurers. Governments need to ensure they support the development and regulation of these services so people have adequate access to them.
In addition, we view financial education as an essential component on retirement policies.”
In 2012, the OECD created the Roadmap for the Good Design of DC Pension Plans as guidance, which was approved and endorsed by OECD pension regulators. Previous editions of the OECD Pensions Outlook have addressed a variety of issues which were prevalent at the time. The latest edition continues this sequential approach and suggests ways to improve the design of DC pension plans, as well as possible improvements to pension policies.
Report highlights:
In most OECD countries, the tax treatment of retirement savings provides an overall tax advantage when people save for retirement, but while this can encourage people to save for longer periods, it does not necessarily encourage saving more. The report suggests that simpler tax rules may increase people's confidence and therefore help to increase contributions to private pension plans.
Policy makers need to ensure that consumers receive appropriate financial advice for retirement. Measures need to be put in place to ensure that the conflicts of interest that advisers face are mitigated and that advisers are adequately qualified. However, attention also needs to be paid to ensure the continued accessibility and affordability of advice, an area in which technology-based advice can potentially play a role.
A coherent framework for retirement is needed to accommodate and encourage the use of annuity products as they can play an important role in helping individuals mitigate investment and longevity risks. However, increased product complexity heightens the need for appropriate financial advice and comprehensible product disclosures to ensure that consumers purchase products suitable for their needs. It also underlines the need for the regulatory framework to adapt to innovations in product design and encourage appropriate risk management for annuity products.
Low financial literacy poses serious challenges, as individuals are increasingly responsible for managing their own retirement wealth. Financial education for retirement planning should be implemented, whilst information about pension should be available, clear and not overwhelming for individuals; where possible it should be standardised (e.g. costs, fund performance). All information for individuals’ pension plans should be combined and available to use with calculators/simulators in order to provide greater insight.
In half of the OECD countries, civil servants’ future pension promises measured in terms of replacement rates are 20 percentage points higher for a full career than those of the private sector. The OECD recommends a pension framework that covers all workers identically; this should facilitate labour mobility and increase efficiency.
Annuity products are an important instrument for individuals to be able to address longevity risk. The UK has successfully developed the market for enhanced annuity products, which offer higher income levels to individuals with lower life expectancies, and provide a solution for individuals who otherwise would have been disadvantaged from the purchase of a regular annuity. The UK experience provides:
a cautionary example of the potential consequences of a one-size-fits-all mandate for the purchase of annuity products; over 15% of annuities sold in 2012 were for funds of less than GBP 5,000, which is not sufficient to provide a meaningful level of income.
an example of the need for default options for annuity products to be carefully designed. The tendency for individuals to take an annuity from their existing provider and not shop around for the best rate resulted in reduced competitive pressure on annuity providers.
To download OECD's Pension Outlook 2016 please click here
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