Today’s post is by Markus Schuller, Panthera Solutions
The trends we discussed in Part 1 are influencing how we structure financially feasible pension systems. EU28 pension systems are well researched by European institutions and the OECD (here, here and here for example) They are rather moderate in their conclusions as these tend to carry politically explosive messages, notably: the first pillar is becoming more and more an anti-poverty provision, leaving it to the second and third pillars to secure an adequate retirement income. So how can we stimulate Pillars II and III? (The “three pillars” come from a 1994 World Bank publication describing: “a publicly managed system with mandatory participation and the limited goal of reducing poverty among the old [first pillar]; a privately managed mandatory savings system [second pillar]; and voluntary savings [third pillar]”).
A total of EUR 1 717 billion (gross) was spent across the EU on pensions in 2012, representing approximately 13.3 % of the EU GDP. Expenditure varies considerably between countries. Greece spent 17.5 % of GDP on pensions in 2012, more than any other country, while three others (Italy, France and Austria) also spent over 15 % of GDP. Estonia, Ireland and Lithuania, meanwhile, spent 7.9 %, 7.3 % and 7.7 % of GDP respectively on pensions (see EUROSTAT Social Protection Statistics).
The EU Commission and EU regulators are increasingly taking on the task to regulate and stimulate the use of Pillars II and III. On January 30th, 2015, the European Insurance and Occupational Pensions Authority (EIOPA) published a statistical database for occupational pensions in the European Economic Area (EEA). This publication represents an important financial stability data source allowing EIOPA to better monitor developments in the market and identify at an early stage trends, potential risks, and vulnerabilities. Currently 21 of the 28 EU jurisdictions have provided information for this database.
In July 2014, the EC called EIOPA for advice on the development of an EU single market for personal pension products. The original timeline, as mentioned in an EIOPA presentation from October 2014 has changed. EIOPA will now publish a consultation document on how a single market for personal pensions could be created in July 2015. As EIOPA’s Task Force on Personal Pensions has not yet drawn final conclusions, no documents are publicly available yet. Stakeholders will be asked to respond to the issues raised in the consultation document between the beginning of July and the beginning of September 2015 during a public consultation. EIOPA will then answer to the Commission’s Call for Advice by 1 February 2016.
In short, the European Commission and EIOPA are currently trying to understand the market for personal pension products. The EC is asking the right questions in this document, from a push towards an EU-wide framework, over solving principal-agent issues to a push for multi-pillar diversification. In order to support the EU institutions in their orientation phase, I suggest the following for the third pillar.
- Include Single Market for Personal Pensions in Capital Markets Union (CMU) Framework
The European Commission’s Green Paper on establishing a Capital Markets Union until 2019 currently focuses on 5 aspects to facilitate capital market based debt financing for SME and infrastructure investments. Rightly so. Having said that, ensuring adequate income in retirement through direct capital market exposure is equally important. So far, the Green Paper does not even mention the third pillar. It only touches the second pillar lightly in two short paragraphs. The hopefully bold proposals from the “EIOPA Task Force on Personal Pensions” in Q1-2016 on how to strengthen the third pillar in EU28 need to be added as priority to the CMU framework.
- Product Structures in the Client´s Interest
Up to now, third pillar products like the Riester Rente (Germany) or the Private Pensionsvorsorge (Austria) are based on the belief of the Greater Fool Theory. Product managers and distributors hope to find an even greater fool that signs up for a fee-overloaded, inflexible, intransparent and strategy-constrained financial instrument. Consumers are taking the bait of a minor government subsidy while ignoring the significant downside of those products. And it works (see here, here and here). Instead, consumers need to be offered a low-cost, transparent, flexible and strategy-unconstrained vehicle to participate in the long-term rise of the global capital stock. US FinTech providers show the way. Traditional capital market access via costly gatekeepers like IFAs, Banks and fund managers needs to be avoided.
- Regulatory Approach
Personal pension plans (PPPs) are covered by many sectoral EU-laws, or none (21 out of the 80 PPP’s surveyed in the EIOPA database have no EU legislation applicable). PPPs should have their own simple and clear regulatory approach. It should facilitate competition amongst financial services providers to offer a low-cost, transparent, flexible and strategy-unconstrained PPP-vehicle. It also needs to overhaul incentive structures to solve currently pressing principal-agent issues.
- Capital Markets Education & Cultural Change
Without educating the private investor on capital markets know how, PPPs will not achieve the reach and level of acceptance required. This education needs to take place in a cultural environment in which capital markets are not demonized by governments. This is a rather self-evident insight, though not necessarily followed by continental European politicians. Even if education and societal sentiment are in place, the inequality momentum will restrain large parts of the population from being able to sufficiently save money for capital market investments. Governments need to offer more significant tax shields – e.g. by automatically transferring parts of the paid income tax to the third pillar account of the citizen.
- Civil Society Research Support
Despite significant research being conducted on EU28 first pillar pension systems, the databases and research publications on PPP are nascent. In addition to EIOPAs current effort to establish the research infrastructure, civil society support should be facilitated to help conduct research and raise public awareness. Is it via lobby-like institutions like a TheCityUK for PPP topics or by installing a “Kapitalmarktbeauftragten” (capital markets commissioner) like in Austria – where a good idea failed due to political reasons. Such a commissioner could be appointed by the parliament and equipped with sufficient freedom and budget to promote the topic through new initiatives.