There is much that I am in accord with what is presented in the article titled Towards a Sustainable Pension System (15 October 2015). I do not, however, agree with some underlying conclusions. I understand that financial providers see market opportunities in the opening up of savings for retirement through a mandatory second pension (MSP) or an automatic enrolment pension (AEP) scheme. The impression conveyed by financial services providers is that a sustainable pension system is achievable only through such a framework. This is not correct. Allow me to explain why.
For many, the State pension is and always will remain the main source of income in retirement. Sustainable pension reform is achieved by securing an adequate State pension - one that provides adequate income to secure dignity and protect against poverty. The challenges to achieve this are not to be understated: the issues of the demographic deficit (low fertility rate and ever increasing longevity), have to be countered by policies directed to increase female and elderly active participation, drawing people from the shadow to the formal economy, leveraging migrant human capital, etc.
These are complex policy developments that mature over the long-term. When pensions reform was launched in 2004 active female participation was 32%. Today this stands at 50%. This did not occur by chance. It is the result of comprehensive reforms - including soft measures directed to inculcate a culture that accepts that a woman can be both a mother and a worker to the introduction of free child care, etc.
There is no sustainable pension system without a strong State pension. This is because the "common" yet "unfounded" opinion that all persons should save for retirement is not correct. There will always be consistently lower earners and where the State, through pensions and benefits, provides them with a sufficienctly high replacement rate without additional saving. For these individuals it is, indeed, not beneficial to redirect income during working life into pension saving.
Since 2004 all reform initiatives recognised that adequate pensionable income will not certain provide individuals (with a salary higher than the 2/3 maximum pensionable income ceiling) with a quality of life equal that such individuals enjoyed during pre-retirement. All reform proposals, including those presented by the Strategy Group this June, underline the importance of self-responsibilisation if an individual seeks a quality of life in retirement that is equal to that enjoyed in pre-retirement: wherein such an individual redirects income income during the working life into pension savings.
While the different pension groups were consistent on the importance of introducing instruments that allow persons during their working life to save for retirement they were not constrained by dogma. The 2004 Working Group emphatically articulated that people should boost their pension retirement income and that this should be done outside of the State pension. It argued that an increase in NI contribution would not increase an individual's pension income as the contribution paid would be directed to the consolidated fund. It was argued for the introduction of a MSP regulated under IOPS principles to complement the State pension.
The 2008 financial collapse and its impact on private pension savings provided a salutory lesson for those in favour of an IOPS regulated MSP. In the immediate aftermath many retirees saw their private pensions "pensions pots" wiped out. The 2008 financial tsuami exposed the fragility of the "prudent person principle" as the crisis itself was the result of the blatant disregard by financial providers of this principle and the inability of supervisory authorities to monitor, detect and rectify ex ante abuses and mis-management.
A key question the 2010 team grappled with was the design of a MSP if this was to be introduced. The team differentiated between a risk faced by an individual mandated (by the State) to invest in pension savings and one where an individual voluntarily (even if incentivised) invested in a third pension (TP) - individual or occupational pension (ORP). The team concluded that while IOPS qualitative and quantitative investment criteria sufficed for a voluntary savings in a TP they did not provide the necessary level of protection when an individual is compelled by the State to save in a MSP.
The 2010 team identified one other important differentiator between mandatory and voluntary self-responsibilisation. A functioning financial services market assumes that people are financially educated and are able to reach the right decision in designing and managing their investment portfolio. Maltese persons have limited exposure to financial education. The team concluded that mandating savings in a MSP under a market environment places individuals at risk given their limited financial education. The team concluded that a MSP should be introduced under the Social Security Act with ad hoc investment principles and guidelines for a default fund similar to the then Swedish AP7 Default Fund.
The thinking with regard to identifying the most appropriate vehicle that allows individuals to complement their State pension by redirecting income income during their working life matured further by the time the Strategy Group presented its recommendations this summer. The Group was criticised for failing to present recommendations with regard to a MSP. What such critics have not grasped is that the Group moved away from the concept of securing the principle of "self responsibilisation" for saving for retirement through "mandatory" compulsion.
The international concept of "self responsibilisation" for retirement income has changed significantly over the past decade - while the issues relating to governance remain relevant. Countries explored different approaches of how individuals are motivated to complement their State pension through savings accrued during their worklife. This new approach departs from the "pater familias" principle of "compulsion" which underpins a MSP. Rather, this approach is based on "nudging" persons early in life to save for their retirement prior to their consumption profile taking root. This approach is based on "behavioural economics" which counters interia by mandatory enroling individuals into pension saving schemes while allowing them to opt out. This AEP is also known as a "mandatory opt-in and voluntary opt-out" system. New Zealand introduced such an approach - the Kiwi Saver scheme wherein 49% of the population and 67% of persons between 18-24 years of age were enroled by 2012. The UK recently introduced the NEST scheme based on similar principles.
The Group and the referred to article both consider the AEP a more appropriate vehicle than a MSP to inculcate a culture of savings for retirement during one's working life. It is less controversial to introduce as there is no full compulsion and implementation can be staged. Where the Group and the article diverge is the time frame for implementation. The article argues for immediate implementation. The Group recommends implementation to take effect in 2020. Another wasted five years the article argues.
The Group disagrees. If the experiences of New Zealand and UK are anything to go by then the introduction of a AEP Malta scheme is likely to be successful. This means that a large percentage of persons aged 18-24 are likely to remain in a pension fund once mandatorily enroled. There are, however, two fundamental issues that need to be addressed before a Malta AEP is introduced.
The first is governance. The Group supports the New Zealand approach where an individual is initially assigned to a default scheme and thereafter the youth can freely transfer to a market or employer nominated scheme. This provides youths, on mandatory enrolment, with a level of protection wherein they are assigned to a cautious risk based default fund directed to protect their interests. Subsequently, they may decide to remain in the default fund or, as experience is garnered, make active management decisions on their pension plan.
Second, although the financial services market has matured, Maltese youth unlike their peers in New Zealand and the UK are not exposed to structured financial education. Self-responsibilisation is not limited only to the provision and use of instruments for savings for one's pension - MSP or AEP. It should also ensure that such investment made by poorly financially educated individuals do not result in the misallocation of savings for retirement or in significant loss of such savings due to bad decision making resulting from such lack of financial education.
The risks to investors have increased. The MFSA 2013 Consumer Complaints report states that it is "disturbing to learn" of the "approach and conduct of a number of financial entities" which "disregard the essence of the regulatory regime: the obligation to act in the best interests of clients"; where "many investors were provided with products that failed to perform as firms led them to expect"; where investors were "not provided with clear information" and "only got to know the true risks when problems started to emerge" and that "investors sold complex" investments "suitable for "experienced investors" while "others thought they were receiving advice" but realised "when it was too late" that "they were signing paperwork which stated the contrary".
There is no doubt that once an AEP is introduced providers will target the 18-24 years cohort. The Group is unequivocal in its belief that it is incumbent on government to ensure that prior to the introduction of an AEP this cohort (and others) is imbued with structured financial education.
Past dithering on the TP led to a lost decade that could have resulted in accrued financial knowledge on pension savings instruments. Efforts in 2012 to create a vehicle to lead sustained financial education petered out. It is in this context that the Group recommends that an AEP should be considered in 2020. This allows for knowledge and experiences to be gained through the TP now that it is finally introduced. It presents sufficient time for further study and understanding of the Kiwi Saver Scheme, NEST and other initiatives so that an appropriate AES framework is designed.
Most importantly it provides sufficient time for the Commission for Retirement Income and Financial Literacy to inculcate and imbue structured financial education so that today's youths - and tomorrow's pensioners - are able to make effective financial decisions. The Commission for Retirement Income and Financial Literacy is constituted and in the coming weeks will present a draft national strategy titled Retirement Income and Financial Literacy: Knowledge, Planning and Action for public consultation.