The OECD has published a report identifying concerns with and policy options for improving pension provision for workers across its 34 member states. The Pensions Outlook 2018 identifies two fundamental issues undermining efforts to ensure that people have an adequate income in retirement.
The first is behavioural bias, primarily the tendency of people to prioritise short-term spending over economic theory, which suggests they will rationally allocate income over their whole life cycle.
The second is what the report calls "basic" financial education. This includes the obvious though sometimes challenging areas of understanding eligibility rules, how pension benefits are calculated and how contributions, investment returns and retirement income are taxed. For defined-contribution scheme members, the need to accumulate more assets if life expectancy increases to maintain the same level of spending in retirement is generally understood.
Complex issues
But, according to the OECD, basic financial knowledge also requires people being able to evaluate a range of altogether more complex issues.
“These include labour market risks (spells of unemployment and trajectory of wages during the career), financial risks (investment returns, inflation and interest rates), demographic risk (longevity) and political risk (uncertainty about future pension rules),” the report states, as well as the power of compound interest and the debilitating effect of inflation.
To an OECD policy wonk, this might sound like basic information but it’s a big ask. In Cantillon’s experience, the level of financial understanding of the average Irish private sector pension fund member is nowhere near this “basic” level.
Financial provision
And that, in part explains why it has proven so difficult to get people to engage with pensions.
Even the OECD admits that only 56 per cent of adults achieve a “minimum target score” for financial knowledge. And the weaknesses it identifies are pretty fundamental – budgeting, planning ahead, choosing products and using independent advice, as well as poor understanding of compound interest and risk diversification.
Pretty damning, especially in a world where people are increasingly responsible for ensuring their adequate financial provision. It is clear that the uncertainty, the numerous variables and the lack of clear information means many people who can and should save for retirement simply avoid or long-finger the issue.
All of which reinforces the case for introducing a well-designed auto-enrolment regime as soon as possible.
