Tomorrow's investor

Abstract

This article summarises the implications for private pension policy of a 3-year study by Britain's oldest ‘think tank’, the Royal Society for Arts (RSA). It finds that the proper design of a private, funded pension system can add 50 per cent or more to pension outcomes. Few countries have designed and implemented an ideal system, and in consequence there is a significant loss in the productivity of savings and the adequacy of pensions. The article focuses mainly on the situation in the United Kingdom, but incorporates research and examples from around the world. It will be of interest to those involved in the reform and regulation of pension systems in developed markets, and to those involved in the establishment of such systems in the developing world. The RSA's work began by asking pension savers what benefits they sought from the saving system. Through discussion in ‘citizen juries’, it became apparent that most savers did not want a high degree of individual choice. Rather, they wanted a system that could be trusted to make choices on their behalf. Subsequent research suggests that, if properly managed, such trustworthy systems are capable of a high degree of productivity. In economic terms, where there is asymmetric information and principle agent contracting for delivery of long-term benefits, institutional design can make very large differences to outcomes. The work sets private pension policy within the broader context that pension policy makers face. It then goes on to describe an ‘ideal’ pension system, which would have the following characteristics: (i) pensions savings would be collected through some form of auto-enrolment; (ii) pensions institutions would be of a size to benefit from economies of scale; (iii) they would be trustee governed; (iv) their funds would be responsibly and collectively invested; and (v) that the pension ‘promise’ is flexible enough to allow for unanticipated changes in the liability and investment in an appropriate portfolio of investments. Although few countries meet this ideal, in Europe, both Holland and Denmark approximate to it. We note that these countries are generally judged to have some of the best pension provision in the world, and have a significantly different institutional design to that found in other developed markets, particularly the USA. The article notes that, in the United Kingdom there has been a drift away from the ideal design of a private pension system. As a result of a desire to avoid unaffordable pension promises, low-cost, collective and trust-based sytems have been wound down. Recent government policy initiatives have sought to reverse this trend, but their success is dangerously threatened by a lack of focus on the details of institutional design and pension regulation.