Although there is no optimal system of retirement pensions for the circumstances of each country, there are proven principles that make it easier to assess the necessary changes that make them efficient and sustainable.
CFA Institute published an ideal retirement system. Its CEO for EMEA, Nitin Mehta, stated that in Spain pensions are sustainable and, as an advanced country, will maintain a public system, but it is one of the most generous and State’s contribution will most likely decrease.
In the study, 35% of 132,000 CFA Institute members in 147 countries showed concern about aging, deficiencies in pension plans and low savings levels. In fact, Keith Ambachtsheer (Why We Need To pension Revolution, Financial Analysts Journal Volume 71 Number 1), noted a consensus regarding pension systems in most of developed world struggling to generate adequate pensions.
For some the answer is areturn to defined benefit plans, depending on years of work, without problems of coverage, adequacy and security. But these plans unclearly socialize how and of whom risks they are, that do not eliminate, but pass on to the weak. Already John Nash showed they end up in win/lose confrontations. Thus, in the government system, current generations reduce the surpluses at the expense of future generations.
For others, the answer lies in defined contribution plans, where employers and workers contribute in accrual accounts that employees withdraw in retirement. This eliminates the ambiguity with respect to ownership of the assets. But research confirms that most are inconsistent in planning and in making financial decisions. Added to this is the information asymmetry of financial services –too much pay for the economic value of the service– generating mediocre pensions. In addition, the participants bear the risk of longevity.
Ambachtsheer establishes that the optimal pension system must generate a target pension on retirement date. To do this it must prevent behavioural defects, with automatic investment policy adjustments and risk of longevity reduction through a deferred annuity. A study by Cui, De Jong y Estanques (2005) found that this model, in terms of consumption/welfare over a lifetime is superior to defined benefit or contribution ones.
In addition, in Drucker’s vision, addressing the problem of the intermediary and informative asymmetry is critical. Pension funds should have a single mandate to create value for shareholders and economies of scale – low costs –, with governance principles and good practices. They should be based on convictions and skills, rather than external agents with their own purposes.
Is there such a system? Yes, a good example is TIAA-CREF, which has come to cover the retirement of more than three million teachers in U.S., with $350 billion assets. Drucker himself was a participant. Over the course of the working life both the n employee and the employer contribute with up to 18% of the salary to generate lifetime pension. Founded from a grant from Andrew Carnegie in 1918, it has a high participation, avoiding a national pay-as-you-go social security system.
The CFA Study Institute, which includes ten key principles to take into account, shows the best pension systems hold assets of at least 100% of GDP; compulsory contributions of a minimum 8% of wages; replacement rate of at least 60% of average wage; a strong regulatory framework and protection, with basic pension for the poor of at least 25% of the average income, as well as high private pension coverage. To diversify, they must have multiple pillars: a basic public pension that provides a minimum income, mandatory and linked to years of work, a regulated voluntary system and savings outside the pension system. Retirement income must cover 65 to 80% of the average income, with revaluation. In addition, contribution limits should be based on the life cycle. They should include predetermined investment decisions, before and after retirement, regarding contributions above the minimum and the choice of assets. They should be transparent about management and costs, being competitive. They must be flexible with regard to circumstances and ages, allowing to work part-time and allow to receive pension and make contributions at the same time. Although benefits must be collected in monthly payments, between 20% and 40% of the accumulated capital must be available for medicine or care, including disability home remodeling. In any case the benefits must be immediately attributed to the beneficiary and accessible under retirement, death or permanent disability.
Trust is critical and requires strong regulation, protection, good communication, education and counseling. Pension plans must inform their participants of the retirement income forecasted and their management must be independent of the Government and any company. They must also have fiscal support, voluntary savings incentives and compensation for lack of access to the accumulated capital, being intergenerational transmittable in inheritance.
José Mª Serrano-Pubul, CFA and CFA Society Spain member.
