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The Role of Financial Education in the Field of Pensions:
International and Italian Experience
Ambrogio I. RinaldiCentral director, COVIP
Conference on Financial Education
Sofia, 29 June 2010Twinning Project BG/07/IB/EC/02
Commissione di Vigilanza sui Fondi Pensione
Outline
• The specific challenges for improving financial literacy and
empowering members to take appropriate decisions in the pensions field
• Limits of financial education in the area of pensions, its complementarity with other policy tools , and the need for a consistent policy approach
• International and Italian experience with financial education and awareness in the field of pensions and with the connected policy tools (pension design and default options, information requirements and selling practices, supervision)
Specific nature of pension issues makes financial education
particularly important and challenging…
• Very long-term
• Complexity
• Social relevance
• large coverage of population
• pension reforms need to be understood by the public for
political consensus
• Non-recurrent choice (you cannot learn from your own experience)
• Retirement environment changing much (you cannot learn from
your parents)
You cannot learn from your own experience...
pensions are different from retail products purchased on a
recurrent basis – including financial products
• typically the savings put in your pension plan should account
for a substantial part of your wealth
• ....and you should make a comprehensive planning of their
retirement needs since you are young
mistakes made when young will reflect heavily on your
pensions
You cannot learn from your parents...
the retirement environment is changing a lot
• increased longevity
• also health and LTC expenses to increase steeply
• working lives still not adjusting to longevity trend
• birth rate going down, less workers to sustain retirees
• public budget stress and decrease in public pensions
Diffusion of DC schemes and risk shifting to individuals
Individual choice and responsibility
Lack of financial knowledge/ understanding/ awareness/ capability
specifically related to pensions:
• of the changing retirement environment – and the trend for
decreasing public pensions
• of the need to make sound long-term saving plans and to start
saving early
• of the characteristics of different pension schemes and
products
• of the importance and level of costs
• of long-term investment risks
• of longevity risks
...not only in the general public, but also within trustees /
administrators → governance issues
Yet pensions are poorly understood...
• behavioural economics highlight the potential of FE in effectively
empowering people to make informed decisions regarding their
pensions
• Lusardi-(variuos years); Lusardi-Mitchell (2007)
• on the other hand many studies also show the limits of FE and
stress importance of “institutional design” in defining policies in the
field of pensions
• Thaler- Bernanrtzi (2001): “save more tomorrow”
• Choi et al. (2002): “the path of least resistence”
• Mac Farland et al. (2003): “one size does not fit all”
Role and limits of Financial Education
... with particular reference to DC plans:
design of the pension system and and of individual products in
order to simplify individual choice
Automatic enrolment, default options
limits to the number of investment options
product standardization
Information requirements to plan members and other consumer
protection rules (selling practices, etc.)
effective competition btw. plans
supervision to ensure the implementation of rules and the
functioning of the system
Financial Education complements other policy instruments...
• when wisely designed, default options have an informative and
educational value
• Automatic enrolment: first path-finding experiences at nation-
wide level (New Zealand, Italy......UK, Ireland to follow.....)
major issues (connected with FE needs):
administration and marketing costs, competition btw. plans
design of default option (who should set it and how)
need to focus FE efforts on issues most relevant in national
context
need for overall consistency of policy
• e.g. default options should not contradict FE efforts
...Automatic enrolment, default options
International experience on pension awareness and connected issues
OECD • Pioneering work on pension-related financial education and awareness initiated
in 2003; OECD recommandation on Good practices for financial education related to private pensions; developed in 2006 by the WPPP, formally approved by the OECD Council in 2008
• Current work on DC pension plans, investment and default options, pension projections and ways to inform members on the uncertainty surrounding estimates (P.Antolìn and others, 2009 and 2010)
IOPS• Work on information to be delivered to members of DC pension plans (IOPS
Working Paper n.5 by Rinaldi-Giacomel, 2008)• further work planned
EC •forthcoming “Green paper” on pensions will highlight the need for increasing literacy and aawareness inteh field of pensions and the need to mitigate risks beared by members in the funded, DC-based pension regimes through better plan design, regulation and supervision
International experience on pension awareness and connected issues (cont.)
major messages coming from the work of international organizations:
the complementarity between the different policy tools available for managing risks in the context of DC pensions:
• financial education• appropriate design of products and default options
• regulation (information to members, selling practices)• supervision
a consistent policy framework across all the available tools is needed in order to exploit this complementarity
International experience on pension awareness and connected issues (cont.)
Some evidence follows on the information to be provided to members of pension plans in a DC context in different countries, regarding:
•documents to be delivered or made available•investment options•investment portfolio and returns•costs and fees•contributions paid•pension projections
Country General description of the plan
Specialized document on investments
Key developments features/
Member’s balance statement
Personalized pension projection
Pension fund’s annual report
Australia Delivered at joining
Austria Delivered annually Delivered annually
Belgium Delivery annually Delivery annually Delivered 5 yearly to members > 45 on request to all members (coming)
Bulgaria
Chile coming Delivered 4 monthly (1) Delivered annually to members >30 (1)
Costa Rica Delivered 6 monthly
Hong Kong Delivered at joining Delivered 6 monthly Delivered annually
Hungary Delivered at joining Delivered at joining (3) Delivered annually Delivered annually to members <15 years to retirement and >15 of membership
Ireland
OPP Delivered at joining Delivered at joining (4) Delivered annually Delivered at joining and annuallyfrom 2008
PPP Delivered at joining Delivered 6 monthly Delivered 6 monthly Delivered at joining and annually
Israel Delivered at joining Delivered quarterly Delivered annually
Italy Delivered at joining Delivered annually Delivered annually Delivered at joining and annually (5)
Jamaica Delivery at joining Delivery at joining Delivered annually Delivered annually
Kazakhstan Delivered annually
Kenya Delivery at joining Delivered annually Delivered annually
Mexico Delivery at joining (2) Delivered 6 monthly (1)
Poland Delivered at joining Delivered annually Delivered annually
Slovakia Delivered at joining Delivered 6 monthly Delivered annually
Spain Delivered at joining Delivered 4 monthly Delivered annually Delivered annually
Turkey Delivered at joining Delivered annually
UK
OPP Delivered at joining Delivered annually Delivered annually
PPP Delivered at joining Delivered annually Delivered at joining and annually
Information documents: availability (shaded areas) and delivery
Country Multiple Investment Options Default Option Default option: selected features
Australia Very frequent Very frequent
Austria No
Belgium X
Bulgaria No No
Chile Required Required Life-cycle
Costa Rica
Hong Kong Very frequent Very frequent Usually low risk
Hungary Very frequent Required from 2009 Life cycle
Ireland Very frequent Required Life cycle required for PPP
Israel
Italy Generalized Required (OPP) Guaranteed return
Jamaica No (OPP) , Very frequent (PPP)
Kazakhstan X
Kenya X
Mexico Required, 2 alternatives Required Life cycle
Poland No (PPP) No (PPP)
Spain Required, 3 alternatives (PPPM) Required (PPPM) Life cycle
Slovakia Very frequent Reccomended Life cycle
Turkey Very frequent Reccomended Life-cycle recommended
UK Very frequentRequired (stakeholder pensions)
Very frequent (OPP)Life-cycle reccomended
Investment options
Country
Investment performance
Frequency of disclosure of the actual portfolioFrequency of disclosure of
returns Required disclosure of Volatility
Publication of comparative tables on the SA web site
Australia Annual Yes Annual
Austria Annual Yes No
Belgium Annual Annual
Bulgaria Daily Yes X (return, volatility) Annual
Chile Monthly X(returns) Monthly
Costa Rica Monthly Yes X (volatility) coming 6-Monthly
Hong Kong Annual X Annual
Hungary Annual (OPP) 6 monthly (PPP) YesAnnual (OPP), 6 monthly (PPP)
SA website
Ireland Quarterly and annually Yes X (return, volatility)Quarterly and annually
(PF and SA website)
Israel Monthly Yes Annual
Italy Annual X Annual
Jamaica Annual Annual
Kazakhstan Annual Annual
Kenya Monthly Yes (VAR) X Monthly
Mexico Daily X (OPP) Annual
Poland 6 monthly 6-Monthly
Spain Annual No
Slovakia Daily Yes X (volatility) Daily
Turkey Annual Voluntary
UK Annual Yes Annual
Investment performance and actual portfolio
CountryAnalytical
disclosure of all costs
Synthetic cost indicator (ex ante)
Table fee comparison on SA
website Price cap
Limits on fee structure
Australia X X X
Austria X
Belgium X
Bulgaria X
Chile X X X X
Costa Rica
Hong Kong X X X
Hungary X X X
Ireland X X (PPP) X (PPP)
Israel X X X
Italy X X X X
Jamaica X
Kazakhstan X X X
Kenya X
Mexico X X X
Poland X
Slovakia X X X
Spain X X X
Turkey X X (coming) X
UK X (PPP) X (PPP) X (PPP)
Costs and fees
Paid contributions Unpaid contributions due by the employers
Country Information provided by FrequencyWarning system
in placeActivated by Communication to Notes
Australia PF A x PF Members
Austria PF A
Belgium PF A PF Members Disclosure of unpaid contributions within 3 M
Bulgaria
PF A Unpaid contributions are checked by the National Revenue Agency that collects contributions
PF Available on website x
National Social Security Institute Available on website
Chile PF Q x
Costa Rica
Hong KongPF A
Employer M
HungaryPF A
Employer M
IrelandPF 6M x
PF and AdvisorsMembers
Supervisory AuthorityEmployer M x
Israel PF A x PPP management company Members PF
ItalyPF A
Employer M
Jamaica PF A
Kazakhstan
KenyaPF Q
Custodian Q x
Mexico PF PF
Poland A A
SlovakiaPF A
PF Available on web-site
Spain
TurkeyPF A
Custodian On request
UK PF A Trustee Supervisory Authority
MembersDisclosure of unpaid
contributions within 90 D
Contributions
Paid contributions Unpaid contributions due by the employers
Country Information provided by FrequencyWarning system
in placeActivated by Communication to Notes
Australia PF A x PF Members
Austria PF A
Belgium PF A PF Members Disclosure of unpaid contributions within 3 M
Bulgaria
PF A Unpaid contributions are checked by the National Revenue Agency that collects contributions
PF Available on website x
National Social Security Institute Available on website
Chile PF Q x
Costa Rica
Hong KongPF A
Employer M
HungaryPF A
Employer M
IrelandPF 6M x
PF and AdvisorsMembers
Supervisory AuthorityEmployer M x
Israel PF A x PPP management company Members PF
ItalyPF A
Employer M
Jamaica PF A
Kazakhstan
KenyaPF Q
Custodian Q x
Mexico PF PF
Poland A A
SlovakiaPF A
PF Available on web-site
Spain
TurkeyPF A
Custodian On request
UK PF A Trustee Supervisory Authority
MembersDisclosure of unpaid
contributions within 90 D
Contributions
CountryHow, when made available
by PF
Assumptions
Communication of uncertainty
Projection linked
to I pillar
Projections provided on the SA web
sitedefined by Interest rates
Australia Yes
Austria Annually PF and employersTo be set according to the
Pensionskasse contract/business plan
Sensitivity on rates of return: +-1%
Voluntary
Belgium Every 5 years to members aged > 45 Upon request to all members (coming)
not yet defined not yet defined from 2010
Bulgaria Provided by insurance companies on their web-site PF
Chile Annually to members aged > 30 Authority One single interest rate Sensitivity on
contribution density Yes
Hong Kong Yes
HungaryAnnually to members < 15 years to retirement and > 15
years of membershipPF
Caveat
Ireland At joining and annually (OPP from 01.01.2008, PPP)
Upon request to all PPP membersPF’s Actuary According to
guidelines of Society of ActuaryA max rate of return (6%) for
PPPCaveat
Yes
Israel Annually AuthorityAssumed rates of return variable in relation to the asset allocation
Caveat
Italy To be made available annually (OPP, PPP) AuthorityAssumed rates of return variable in relation to the asset allocation
Caveat
Jamaica Annually PF
Mexico Authority
Projection to be made using two rates: 5% for all funds and actual return obtained by each pension fund in the last 36 months
Caveat
Slovakia Upon request (PPP M, PPP V) Ministry of Finance (PPP M)Assumed rates of return variable in relation to the asset allocation
Poland Yes
Turkey Upon request to all PPP RegulationTwo different scenarios: (9% and 11% before 2013 (6% and 8%, from 2013 )
Sensitivity on
rates of return Yes
UK At joining (PPP) and annually (OPP, PPP)
Guidance of Faculty of Actuaries and Institute of
Actuaries (OPP)
Authority (PPP)
For OPP: maximum rate of return (7% )
For (PPP): 5%, 7%, 9%
Caveat
Sensitivity on
rates of return (PPP)
Voluntary Yes
Pension projections
the Italian experience with the introduction of auto-enrolment into pension funds
outline of following slides
•Background information on the development of Italian pension funds since the 90’s
•The implementation of nation-wide auto-enrolment in 2007
•The mixed results and the possible explanations •Some evidence on the role of financial literacy and pension awareness •Policy suggestions from the Italian experience so far
Background info on the development of pension funds in Italy:
The start-up
•Up to the beginning of the 90’s, there was no perceived need for pension funds directed to all workers, as 1st pillar was generous: pension funds were limited to high salary workers (managers of large companies, financial sector employees):
around 700.000 members, or 3% of the work force. •In 1992 (and then in 1995) a major reform of 1st pillar pensions was introduced (including the introduction of the NDC system), that put pension expenditure under control and significantly reduced future benefits (although with a long transition phase). •The need for the diffusion of pension funds to all workers (and especially the young) became clear. New legislation, and a comprehensive regulatory and supervisory framework was introduced in several stages from 1993. A system of “new” pension funds was created.
The start-up(continues)
Main features of the system: • Pure DC
• A leading role for occupational, industry-wide pension funds
• For employers, commitment to contribute linked to labour agreements
• For workers, voluntary membership
• “Open” pension funds (set up by financial, insurance firms) directed mainly to the self-employed, with a residual role for employed workers
The first new pension funds became operative in 1998. At the end of year 2000, there were already about 140 new pension funds in place - about 40 “contractual”, the rest “open” – a higher number that those still in place. So-called PIPs (insurance-like personal pension plans) were introduced in 2001.
The second phase: the need for a push
• In 2004, after several years of starting, the system looks well-built in structural terms, but still with low membership rates: around 3m workers, or 13% of work force.
• After a wide public debate, the automatic enrolment of all employed workers of the private sector was introduced (with the opt-out option), directing to pension funds the annual accrual of so-called TFR (a sort of mandatory severance pay): about 7% of gross earnings.
• Several other new rules were introduced, mainly with the purpose to increase the scope for competition also in the field of occupational pensions. No specific measures were taken for the workers of the public sector and for the self-employed.
• At end-2005 the automatic enrolment was planned for the first half of 2008. Then,
after the elections in May 2006, the new Government envisaged to shift it earlier, to the first half of 2007. The final decision was taken in late 2006. It was also decided that firms with 50 employees would be obliged to transfer to the Treasury the flows of TFR that workers did not want to be paid into the pension funds.
Nation-wide auto-enrolment: implementation in a hurry
With little time available, a “rush” phase started, implying:• The re-drafting of all secondary regulation, to be made consistent with the new law (by
COVIP, the specialized regulator/supervisor); the new regulation included specific emphasis to information to potential members
• The re-organization (by the funds) and the re-licensing (by the supervisor) of the pension funds already in place, plus the setting-up and the licensing of several others
• A campaign for increasing awareness of general public (by the Ministry of Labour):– all media were used, with special emphasis on TV and radio– dedicated web site and call center– monitoring of effectiveness during and after the campaign
• Many, capillary initiatives in the workplace (campaigns and meetings) organized by trade unions, often together with the industry-wide funds
• Detailed information to be supplied by employers to workers at company level
• Marketing efforts by financial firms commercializing “open” pension funds and PIPs
The results so far
a significant, but still unsatisfactory increase in membership: at end-2009, just over 5m members, or 20% of workforce, 27% of private
sector employees (most of the result already achieved at end-2007)
Moreover:• Very few true “auto-enrolled” (or “silent”) workers (at odds with experience of other
countries). Auto-enrolment has continued to be in place for new workers, but still with marginal results
• Membership is very diverse across sectors and funds – mainly depending on firm size and presence of trade unions
• Participation among the young is particularly low
• Competition is still weak across different kinds of pension plans. Costs are also very different, and the most expensive products sell well
Membership before and after the TFR reform
Two equilibria :–a good one (role of social parts, “cafeteria effect”, peer behaviour)–a bad one (little and distorted information)
Contractual pension funds: membership rate and firm size
The structure of the pension funds market in Italy
CPF1
PIPs
Occupational
Personal
CPF2
CPFn
OP Fs
Cost competition in the market for occupational plans5 years time horizon
0,0%
0,5%
1,0%
1,5%
2,0%
2,5%
3,0%
3,5%
Cos
ts %
of
NA
V
Contractual PFs Open PFs
50% Central
25% Best
25% Worst
Cost competition in the market for personal plans5 and 35 years time horizon
0,0%
0,5%
1,0%
1,5%
2,0%
2,5%
3,0%
3,5%
4,0%
Cos
ts %
of
NA
V
Opens PFsInsurance-likePension Plans
50% Central
5 years 35 years
25% Worst
50% Central
25% Best
25% Worst
25% Best
Open PFsInsurance-likePension Plans
Explaining the results Structural and objective factors:
• Low financial literacy and pension awareness among workers to start with• “Saving” (in terms of contribution rates) for pensions is already high – not clear how
much room for further contributions • For the workers, TFR is a strong competitor vis-à-vis pension funds
• TFR is good as a source of financing for smaller firms (below 50 employees) – incentives for these employers do not work in the right direction
• Many workers (particularly among the young) are liquidity constrained. Little room for additional savings
• Financial and economic crisis:
– increases liquidity constraints on potential members– increases need for financing for smaller firms– increases risk aversion, diminishes confidence in pension plans investing in
financial markets
Explaining the results (cont.)
Implementation factors:
• Hurried introduction of auto-enrolment: insufficient time to create awareness
• Insufficient effort to improve awareness on the decrease of 1st pillar pensions in the long run, with some uncertainty about the further measures that may be introduced
• regarding pension funds, some aspects of legislation (e.g. taxation) are complex and difficult to communicate
• Unclear public support for the TFR into the pension funds: “appetite” by the Treasury for the TFR of larger firms
Explaining the results (cont.)
Implementation factors: (cont.)
• ”Conscious” adhesion, or “adesione consapevole” – the importance to choose - was the main theme of the awareness campaign by the Government and trade unions – more consistent with voluntary enrolment than with the “paternalism” that should be implicit in auto-enrolment - some evidence that the campaign did favour the opting out
• No “true” auto-enrolment: filling a form has been made compulsory to certify “non-action”.
• In terms of contribution rate, the default is sub-optimal for the employee (as it does not provide for the employer’s contribution, but only for the TFR)
• In terms of investment option, the default is also sub-optimal for most members: a very conservative, guaranteed investment line
Explaining the results (cont.) Specific issues for personal plans:•Despite efforts made through information requirements, strong information asymmetries between selling agents and potential members are still there
•Application of “rules of conduct“ regulation taken from MIFID is not very helpful: clustering of clients through questionnaires and the resulting characterization of products as suitabile/ appropriate do not address costs, and do not deal with excessive risk aversion
Cost of the product Age of potential member
Exposure to equity risk
Usual MIFID characterization
high young low or nil appropriate
high old nil appropriate
low old low inappropriate
A few examples:
Specific information mechanisms may be needed for pension products in order to make competition work (e.g. comparative information, etc.)
Questions on financial literacy% of correct replies
Entire sample
PF members
not PF members
Compound interest rate 53,5% 59% 52%
Inflation perception 48,5% 53% 47%
Difference btw. stocks and bonds 49% 55% 47%
Risk diversification 53% 61% 51%
Relationship btw. price/yield of bonds 11,4% 12,9% 11%Sample size 981 224 757
Some evidence on financial literacy, pension awareness, and the decision to adhere
In June 2008 COVIP commissioned a survey in order to better understand the factors influencing workers’ choices regarding pension fund membership(telephone interviews of about 1000 employed private sector workers)
The classic “Lusardi-style“ questions were included:
Replies are in line with those of other countries and show a positive (though small) effect of financial literacy of the decision to adhere
Questions on awareness on pension reform(NDC vs. earning-based system, etc.)
% of correct repliesEntire
samplePF members not PF
membersYour benefits will depend: only on the contributions you pay / only on your salary as an active worker / on both / DNK
28,5% 32,6% 27,2%
How large you expect your benefits to be in terms of your last salary: <50% / btw. 50-60% / btw. 60-80% / >80% / DNK
63,3% 70,1% 61,2%
The PAYG system (sistema a ripartizione) is a system where contributions paid today are used for: Paying current retirees / paying future benefits to current active workers / both / DNK
37,2% 44,6% 35%
Sample size 981 224 757
Some evidence on financial literacy,pension awareness, and the decision to adhere (cont.)
A few other questions were also asked:
Replies show a positive effect of “pension awareness” on the decision to adhere Preliminary results of econometric analysis through probit models show a stronger
effect of pension awareness vs. financial literacy on the decision to adhere
Policy suggestions from the Italian experience so far Ensure consistency between education efforts and other policy tools• clear communication on effects of 1st pillar reforms is essential (“orange envelope”, etc.):
cfr. OECD Recommendation, par.2: “promote understanding of the changing retirement environment”
• default options are a strong way to convey education/advice; avoid sub-optimal default options that may contradict education efforts
• policy design should create a incentive-compatible environment (e.g. making pension fund membership of workers at least neutral for employers / Treasury)
• competition across pension products may be greatly helped by financial education, but also needs specific devices (e.g. comparative information, etc.)
Mitigate the high risk aversion induced by the financial crisis• Risk appetite is highly procyclical, make use appropriate investment default options (e.g.
life-cycle, target funds) that help educating members to have stable, long term orientation and an appropriate exposure to equity risk
Policy suggestions from the Italian experience so far (cont.)
Find the right balance of responsibilities between the State (legislation), social partners and individuals. Soft paternalism, nudging, is useful to complement information and education efforts directed to individuals
“One size does not fit all”, but do not escape the responsibility to advice
(trough appropriate default options) “what is likely to be the best” for the average worker
