Making Choices in the Pension Making Choices in the Pension Payout Phase Payout Phase

FIAP International Seminar FIAP International Seminar Investments and Payouts in Funded Investments and Payouts in Funded Pension Systems Pension Systems 29th May 2009, Warsaw29th May 2009, Warsaw

Fiona Stewart

Administrator

OECD Financial Affairs Division 1

OECD’s Financial Education Project Principles for Financial Education and Awareness 2005 Assess efficiency and effectiveness Governments as coordinators/facilitators Involvement of a variety of partners Start as early (school)/ ongoing through life Use a variety of channels + simple messages

High level conferences G8 Financial Ministers recognized OECD work 2006-8 India, Moscow, Istanbul, D.C., Indonesia October 2009, Brazil

Website International Gateway for Financial Education www.financial-education.org

Ongoing Project Evaluation/ Credit Guidelines School programmes/ Intermediaries

2

Good Practices on Financial Education relating to Private Pensions

Rationale:

Unique nature of the pensions products makes financial education particularly important…

• Long-term nature of contract and complexity of products (longevity, inflation, investment, fiscal policies, assumptions on future income

• Wide social coverage and low risk tolerance

• Large number of pension schemes and potential impact on financial markets and economy

….Combined with demographic and systematic trends:

• Increased longevity and shorter working lives in most countries

• Decline in public pensions

• Shift from DB to DC schemes

• Increased individual choice 3

Good Practices on Financial Education relating to Private Pensions

Key messages Role of governments :

Develop and coordinate wide public awareness campaign Explain the interaction between public and private sources of

retirement income Inform on pension reform and increasing individual responsibility Ensure the provision of sufficient, practical and simple information

on pension issues and on pensions projection Establish dedicated school programmes

Specific needs of members of DC schemes Role of key stakeholders : plan sponsors, pension funds,

fiduciaries, intermediaries and social partners Limits of Financial education: regulation of pension scheme

Importance of appropriate disclosure on pension products Automatic enrolments and default options, framing and limiting

choice

4

Challenges in Selecting Products for the Pay-out Phase

1. Choice Between Products• Rise DC pensions makes transition to decumulation phase important

• Individuals risk making choices which could lock in suboptimal pension payouts for the rest of their retirement

• Complicated nature of pension and annuity products makes individuals dependent on advice receive – often from sellers of the products

• Making choices between products time consuming and difficult

• Demand for voluntary annuities is often lower than expected.– Seen as inflexible and illiquid products, can’t access funds, can’t leave

money as bequests, may be locked in at poor rate– Seen as bad value, think money goes to insurance company if die early,

don’t understand risk pooling What should policy makers do?

5

Financial Education and Payout PhaseIndividuals may be right: • Maybe high levels of annuitized retirement income from PAYG-financed and

DB pension plans • Logical preferences related to liquidity or bequest motives• Maybe inefficient mispriced markets (lack of supply/ adverse selection

problems)Then no policy response or improve annuity supply

Individuals may not know that flexible products exist:• Real annuities protect against inflation• Impaired life and enhanced annuities address adverse selection• Deferred annuities allow for flexibility over timing• ‘Flexible annuities’ control payouts /investments• Some products may allow for the inheritance of capital• Some allow payment of long-term care or healthcare costs

Policy makers need to ensure that suitable products are available and that consumers understand them properly

6

Financial Education and Pay-out PhaseIndividuals may be wrong • Research shows perception of annuities can be changed by how they are

‘framed’ or presented in comparison with alternative investments - an investment frame vs. consumption frame

• Implies knowledge and understanding of products poorFinancial Education and Awareness can help

• Governments could take a lead in improving knowledge of annuities• Education may be provided by employers at the point of retirement• Information and advice on annuities may be incorporate into financial

education relating to pensions and savings as a whole• Need to ensure that financial intermediaries provide appropriate advice /

check that clients understand the products they are purchasing • Regulators could provide easily understood and comparable information

on annuities products

7

Challenges in Selecting Products for the Pay-out Phase

2. Ensuring Best Annuity price• Where annuitization compulsory, ensuring the best price is the

challenge (may be ‘locked in’ to provider from accumulation phase can’t shop around)

• Several countries provide centralized system for comparing annuity prices

• Such systems can help to increase knowledge and understanding - particularly when coupled with some product explanation or advice

• They may also deliver cost savings and efficiencies (via potentially lower marketing and distribution costs for providers) and also assist with the timing of an annuity purchases

• In most countries, comparative annuity quotations can be obtained via third-party advisor or brokers

• But they may be paid by commissions, be tied to one provider, may not be able to provide advice, or be unwilling to take on clients with small balances

• Impartial advise provided by public sources is preferred 8

CHILE• At retirement individuals above a minimum wealth threshold use their

accumulated savings to purchase an annuity product from an insurance company or receive a PW from an AFP ( PW/ Immediate life annuity/ Temporary income withdrawal + Deferred Life Annuity / PW+ Immediate Life Annuity)

• Free choice of annuity led to a network of salesmen and high commissions paid - with annuity purchases rising (PW low profit for AFP)

• To make the process more transparent and competitive an electronic quotation system was introduced in 2004 SCOMP

Number of Pension by Mode Source SAFP

90

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Programmed Withdrawal Life Annuity

How SCOMP Operates

10

Results• System worked well over 4 years – information + access to

market appreciated (especially for those in rural areas)• Providers resisted compulsion + fee caps – but worked with

system• Technology (interconnection between agents) challenge• Only 12% finalize process without paying commission (very

few opt for auction)– suggesting most still want help of an intermediary – working to simplify information further

• Using an intermediary more likely to accept the best quote• Many accept quotes outside system – but 2/3 taking best

quote – system helps overall selection + MW dispersion annuities declined

• Commissions capped at same time – now average below ceiling

11

UK• In terms of supervising the transition to the pay-out phase, financial

authorities in the UK have also been introducing some innovative arrangements

• To ensure a more competitive annuities market, FSA introduce Open Market Option (OMO) 2002 - pensioners must be informed of right to purchase their annuities from suppliers other than their current pension provider

• After several years of operation OMO was only partially successful (only 1 in 3 individuals switch to a different provider, despite differential incomes as much as 30%)

• System improved - FSA introduced centralized, comparative annuity prices

• Individuals asked a set of standard questions on the type of annuity they would like and comparative quotations from the providers are then given

• Participation voluntary basis but all the main insurance companies are represented

12

13

14

UK • UK government decided ensuring individuals obtain competitive prices

for annuities may not be sufficient - evidence suggests they are also not choosing the right product

• Experts suggested for OMO to work annuity selection must involve 2 stages:1. Ensure individuals select the right type of annuity product2. Secure competitive quote

• 2-stage system developed - the Pensions Advisory Service (TPAS) developed an online system to help individuals choose what type of annuity is right for them

• Individuals guided through a series of questions leading to a tailored answer as to what type of annuity would suit their circumstance (e.g. asked if married or single – then given information on single or joint life annuities + when the latter may be valuable)

• Respondent is then guided to the FSA’s comparative tables to find the best price for the product they have selected – or has a better understanding when consulting with a financial advisor

15

16

Lessons for other countries• Informing individuals of their right to get a quote from an alternative annuity

supplier to their pension provider may not have sufficient impact• Comparative quotation systems add value and improve annuity choices + can

reduce costs and commissions• Compulsory participation by providers may be necessary to ensure full industry

involvement and overcome resistance• 2-tier systems providing information as well as quotes are preferable• Government organized or supervised systems can ensure broad coverage and

provide credibility • Involving a wide range of players in system development is helpful - if

challenging• Standardized system are relatively economic and not too technically challenging

- though need to make sure sufficiently flexible software used• Information and data need to be understandable to a broad audience• Given low levels of financial literacy and confidence with these products, building

a role for intermediaries to provide advice and assistance may still be recommended - but free, objective provision of such information from government sources may be desirable (particularly for those with low balances who may not be able to access or afford such advice)

17