THE State’s new auto-enrolment pension scheme, which is set to be launched in 2022, eliminates many of the current frictions which act as a barrier to more than half of the working population having a pension.
If carefully designed and executed, auto-enrolment has the potential to play a key role in Irish society. However, mistakes made around investment or platform design, will trigger perceptions of unfairness, with consequent effects on success.
What are the frictions to having a pension?
There have been tremendous advances in understanding of individual behaviour. Individuals overwhelmingly favour ‘Default Options’ (the option that happens if the individual does nothing).
Currently, the default option for many individuals is not to have a pension, as their employer doesn’t offer a pension scheme (or they are self-employed). By introducing auto-enrolment, the default option for these people will be a pension. Once people are auto-enrolled into a scheme, international evidence suggests they stick with it.
There are additional benefits particular to the new scheme.
First is personal choice. One argument against auto-enrolment is that individuals can’t afford to set aside savings for their retirement. The proposed scheme allows individuals to opt out of auto-enrolment after six months, with the refund of contributions.
Second, is that employers must match employee contributions. Every one euro invested in the pension, by the employee, is matched with one euro from their employer.
Third is the financial incentives. The new scheme will be incentivised through both tax relief and, potentially, exchequer matching of contributions.
What decisions have yet to be made?
There are important decisions yet to be made.
Surprisingly, technology was not mentioned in the recent Government progress paper on auto-enrolment.
Technology as an enabler for members to interact with the scheme will be at least as important to success, as other decisions. It is imperative that advances in technology are leveraged to allow pension members interact with their pension scheme in ways which build trust, and acceptance levels.
Should it be within State control or privatised?
The expertise to administer and manage a pension scheme for potentially half of the working population does not exist in any state body. There are private sector providers with the capability and expertise to design and deliver a scheme of this scale. These companies are privately owned, operating on the basis of maximising fee income, meaning their interests are not fully aligned with scheme members.
According to the progress paper, a state body, the Central Processing Authority, will be responsible for contracting a limited number of private sector Registered Providers to offer a range of retirement savings products.
Effectively, the state body will administer the scheme, but all of the investment decisions will be made by the scheme member, who has limited expertise, and the private sector Registered Providers.
There are disadvantages to this approach, including too much complexity for the scheme member, and a lack of economies of scale, due to too much choice.
There are alternatives
Consideration needs to be given to instead setting up a new company, NewCo, which is owned by the members of the pension scheme, and make NewCo (subject to government reporting, an expert international board and stringent regulatory oversight) responsible for the management of the scheme.
There are several advantages to this approach.
First, incentives are aligned. If the company is owned by the members of the scheme then any profits made by NewCo will be passed on to the members, as NewCo owners.
Second, NewCo will have economies of scale when it comes to investing. By creating one default investment option (with differing maturities and time-varying risk levels) it will be able to negotiate low fees with international investment fund providers. The default option can have more diversification, meaning the same level of performance, at lower risk.
Third, this approach will be simpler, enhancing acceptance. Rather than having to choose between different Registers Providers and savings products, there will be one default option from NewCo.
Fourth, NewCo will be in a position to leverage technology, to provide all relevant information in a fully transparent, easily accessible way. The role of technology cannot be understated in boosting trust and acceptance.
To be successful, NewCo will have to recruit professional investment managers and technology experts. Investment managers must have strong incentives to continue to enhance investment options, and exert downward pressure on fees.
Technology experts must be incentivised to leverage technology to boost trust and acceptance, while reducing costs.
If well designed, scheme members will be able to access all information on their pension on a digital platform, encouraging acceptance and take up of the scheme.
With good investment performance, scheme members will have a healthy top-up to the state pension at retirement.
Professor Mark Hutchinson, an internationally recognised expert on Investment Management, is Chair of Finance at Cork University Business School, University College Cork.