What can help improve people's pensions in the UK?

0:12Welcome to the latest episode of Margin Notes with me, Simni Kiriakou, editor of FT Advisor. Over the past year, we have discussed various aspects of risk, whether relating to business, investment, technology or protection. Today, we're exploring the risks the UK faces in terms of retirement resilience. With an ageing population and higher than ever levels of working age people not in employment, the welfare and pension bills are putting enormous pressure on the nation's coffers. Millions of people are underfunding their own retirements and hoping that the state pension safety net will remain as it is in place for them in 20, 30 or 40 years time.

0:52This is unlikely. So can international experience and behavioural finance combine to help improve retirement outcomes in the UK? Our guest today, Dr Seda Paksevim, has spent years working on international pension systems, behavioural finance and retirement saving. Seda has collaborated with organisations and universities, including the OECD, the CFA Institute Research Foundation, MIT and pension providers across many different countries. She's the founder and managing director of Pension Research and Consulting. Seda, thank you for joining us all the way from Istanbul. Thanks for having me, Simone.

1:32It's great to be here. Fantastic. Well, let's get straight into it. Seda, what lessons can the UK draw from international experience of retirement savings? That's just a big question to start off with, isn't it? Yes, but that's a great question in this. I will be a starting point, I think. When we look at the accumulation part of retirement planning, Simone, We can think of it in three phases, participation, contribution, and investment performance. And the most important starting point seems for me to be participation. And in the participation phase, indeed, the United Kingdom has actually been very successful with the automatic enrollment program, particularly among eligible employees.

2:14And this is really the magic of behavioral economics. So participation rates increased considerably while opt-out rates have remained relatively low, like in 11 to 12 persons, according to the new figures. But this does not mean that the participation problem has been solved for everyone. Once overall participation increases, the next question is about adequacy. Yeah, how much? Yeah, great. So are people saving enough? And at the same time, I think this part is very important. there are still important groups, vulnerable groups, that are harder to reach through traditional workplace pension systems.

2:51These groups are self-employed and informal workers and people on low or irregular incomes, where the automatic enrollment program in the UK do not cover these people. So for these groups, the challenge is both how to increase participation and how to increase total retirement savings over time. And internationally, I think we are seeing a shift from, how can I say, simply asking people to save more towards making saving easier and more automatic. So we should make saving more easier and automatic for people. And some of the most interesting examples and innovations are actually coming from emerging market countries.

3:29So always, yeah, always we are discussing that emerging market countries should copy the developed market countries' pension systems. But I think also developed countries such as the UK can draw many lessons from international experiences. For example, one of the interesting approaches is saving through consumption platforms today. And we see these types of platforms in Mexico with Milas para el Retiro and in China like Poynchumo. And for instance, these saving through consumption platforms work in the following way. You simply register your credit or debit card with the platform. and when you purchase an item from one of the participating stores, a predetermined percentage of your consumption can be transferred directly to your retirement savings account.

4:16Kind of like rounding up then. Sometimes you ask to round up for charity. So they say, well, do you want to round up? Yeah, this is very simple. This is a very, I'm sorry, similar experience to round up apps, but this is a bit different, Simone, because you predetermine the percentage of your consumption, how much your consumption will be linked to your savings account. It's a predetermined percentage. And in addition to this, some brands, such as in Mexico, Amazon, Starbucks, and Lockton, do not make a discount on a certain product. Instead of, they are adding these benefits to your retirement savings account.

4:53So instead of making a discount, yeah, they are linked this consumption to your retirement savings account, this benefit. That's an interesting concept. And I'd like to sort of pin down some aspects of this. In Mexico and in China, when people save into workplace pensions, does that come out? So in the UK, when we save into our workplace pension, it comes out before tax. Yes. But what you're talking about is post-tax income. So the income that comes out after tax has been taken out, I'm then putting that into my pension saving. Are you suggesting that the UK could do both or that we could perhaps just encourage people to save into a different kind of pension wrapper like a SIP, but using a platform so when you spend money goes into your SIP?

5:45I think both of them are crucial. So the first pillar should be exists like in the UK, like it exists in the current state. But also these platforms can work in like a fourth pillar of pension systems in addition to the third pillar. So I think these platforms can be particularly useful for the vulnerable groups, like irregular income groups, low income groups, self-employed people, which cannot be covered by automatic enrollment program in the UK. Because I think we should also focus on these people. And also, I would like to say another interesting example comes from Africa, Nigeria. 19 % of employment is informal in Nigeria.

6:26And providers such as Avaba have therefore been looking at how technology can extend pension saving to informal and self-employed workers, which is also, I think, particularly crucial for the United Kingdom. Informal employment is not so much high in the United Kingdom, but I think these vulnerable groups should be also extended to the pension coverage. And how they do it, ABBA has been specifically designed to address this gap and has become Nigeria's first PANCOM accredited pension agent. So they combine technology with a distribution network, like how can I say, using agents, digital onboarding, and direct debit infrastructure to bring people from the cash economy into digital pension savings.

7:09So I think while these informal employment, irregular income, low income issues can be seen as a particular challenge for emerging market countries. I think what UK can draw international lesson from emerging markets is how they can also extend, the UK can extend pension coverage for low income people, irregular and self-employed people. So I think, yeah, the main lesson they can draw is this one. That's really useful. And I'm going to sort of flip to, because obviously we had some questions we've been discussing before the podcast, but I'm going to flick then to one about AI and technology, because in every single example you've given, whether it's Mexico or China or Nigeria, again, is that use of technology, of platforms, of maybe some kind of open banking that is enabling people who are not in a workplace or necessarily saving enough for a state pension to be able to make post-tax income savings into a form of pension.

8:11Could you talk a little bit more then about sort of how the role of AI or the role of technology could be used globally to help plug the pension gap? Yeah, great question. I think the technology part has been mainly discussed for the UK and other developed countries, but I think also AI has enormous potential. But there is an important distinction similarly. So technology cannot solve an eduquisi problem in my view if contributions are simply too low. But technology can help particularly solve behavioral problems. So historically, pension communication has been quite generic. So we might send thousands of people essentially the same message.

8:52You should say more in different contexts. But people are different. They have different incomes, different spending patterns, different financial circumstances. And AI indeed gives us the possibility of making these interventions much more personalized and timely. So we can have a better timing with AI when we are sending messages to these people. For example, if someone receives a salary increase, that might be the ideal moment to suggest a contribution increase, which is also called automatic escalation and has been applied in some of the companies in the United States. And if someone changes jobs, that might be an opportunity to deal with small pension ports.

9:37So AI can tell us the better timing for personalized messages. So I think for this behavioral communication, AI has an enormous advantage. And also, there is a broader role for technology beyond communication. We generally discuss in the UK context or developed market context, the role of communication. But there is also a broader role technology beyond communication, I think, similarly. So, for example, digital micro-pension platforms can make pension saving much more accessible for people like who are, again, vulnerable groups, like self-employed people, informal workers, or people with irregular incomes.

10:16And instead of assuming that everybody receives a predictable monthly salary, so digital platforms can potentially allow people to make smaller, maybe daily, maybe more flexible and more frequent contributions using mobile technology and digital payment infrastructure. So also another interesting idea comes to my mind, I think, in this context is blockchain technology. So, yeah, I think this is very critical for pensions world, pension ecosystem. We have already seen experiments in the Netherlands. Dutch pension administrators developed a blockchain prototype for pension administration. And the potential benefits here are quite different from AI because blockchain can potentially make pension administration more transparent, more secure and more efficient.

11:08And it can also at the same time reduce administrative costs and making it easier for different parties in the pension system to share and verify information. So when we talk about technology and pensions, I think we should think quite broadly. So AI can improve personalization and timing. At the same time, digital platforms can improve access and contribution mechanisms. And technologies such as blockchain can potentially improve the infrastructure behind the pension system. So the objective isn't to turn millions of people into pension experts. So it's to use technology to help people achieve better outcomes without requiring them to become experts.

11:54Exactly. And just to make things a little bit easier, maybe a little bit more democratic, give people more options than they might they might not be able to have access to workplace pension especially if they're not doing enough hours or you're depending on their age or their earnings so i think this is a really interesting point and there are certain things that we could learn and put in place um but let's talk now about the other side of the coin you know we can make it easier um we have a phrase in the uk which calls you can lead a horse to water but you can't make could drink we can do everything we can put all the right technology in place we can create these platforms which could be based on using facebook or or anything we could create these platforms but how do we change people's behaviors or how do we develop help them develop more resilient savings behaviors that's a great question and it's also one of the most important areas in behavioral economics, I think.

12:50So there are, I think, three behavioral problems are particularly important in pensions world. So inertia, present bias, and complexity. I think people often struggle with these biases. And so because retirement might be 30 years away, but your electricity bill is this month. So naturally, immediate needs to receive more attention. And this is essentially the problem of present bias. So we tend to give much more weight to costs and benefits today than the benefits that may arrive decades into the future. And pensions are particularly vulnerable because the cost of saving is very visible, but the benefit is distant.

13:30So automatic enrollment deals with this inertia extremely well in the UK because doing nothing leads to saving. But we can go further. As I mentioned earlier, for example, by exploiting this behavioral bias in people, The UK also introduced automatic escalation approach, Simulay. Instead of asking somebody to sacrifice more income today, you can encourage them to commit in advance to increasing their pension contribution when their salary increases in the future. So I think that's really very powerful. So think about like that. So many people may resist losing 50 pounds from their current monthly income, but they may be much more comfortable agreeing today that part of the future of their salary will go towards their pension.

14:19They will agree today, but their monthly salary income will shrink when they have encountered with a future salary increase. Right. Yeah. This is, for example, one of the main ways of, I think, exploiting behavioral biases. So rather than eliminating, for example, present bias or inertia, we can actually design it. We can actually design around it. So, and the third issue is complexity, I think. So, pensions are inherently difficult for many people. So, you're asking people to think about their contribution rates, investment risk, future returns, and retirement income. And when decisions become too complicated, people don't necessarily make a bad decision.

15:06Quite often, they make no decision. And this is where technology can also help by reducing friction. So as I mentioned, Avaba, Nigeria, and African platforms, Mexico's Milas Paral Retiro, like these platforms do not only rely on technological principles. They also rely on behavioral principles. Yeah, exactly. Why people are struggling from these behavioral biases. And these platforms trying to integrate technology in addition to these behavioral biases. And if saving requires too many decisions at the end of the day, in too many forms, too many passwords, or for example, simply remembering to do something every month, people often postpone it.

15:48And this is particularly relevant when we think about self-employed workers, as I mentioned, or people with irregular incomes or low incomes, which are not covered by the automatic enrollment program in the UK. So for me, that's the main lesson. the objective shouldn't be to make people perfectly rational or turn everybody into a pension expert. Because knowledge does not necessarily change their behavior. It should be to design pension systems in which good retirement behavior becomes easy, automatic and timely. And I think we should use technology and behavioral principles to create an environment for people.

16:26Yeah. Yeah. I think that's a really important point. You know, it's creating those options and communicating those options and making people very aware of them. Now, I'm just going to look at sort of regulation because obviously we operate in a very highly regulated environment in the UK, quite rightly so. And one of the key points is that any new product that comes to market or new sort of financial product in the investments in the pension space ends up sort of having to go through sort of regulatory channels in order to get themselves set up and regulated. Have there been any regulatory roadblocks that you know of in other countries that have prevented these things from starting up?

17:12And if so, what could the UK learn before they just go ahead and start trying to launch these things? Great question. I think the United Kingdom may also look at other automatic enrollment programs and their regulations. Many emerging market countries have also introduced some automatic enrollment programs, not only developed markets such as Italy or the United States, but Poland, Lithuania, Georgia, Turkey, my country. In 2017, we also introduced autonomous program and we have many different regulations. But I think what is the common point among those regulations is about default funds. Right.

17:52Indeed, I would like to bring up your point to the default fund because I think the regulation part becomes very important when we are talking about the default fund design. Yeah, it's our default at fault. Yeah, yeah, yeah. Great. So because many countries have similar arrangements in terms of employee contributions, employer contributions, state contributions, in terms of other regulations. But when we come to the default fund, generally, every country start to introduce age-based funds. So depending on the age of an employee, they're offering default funds. This is a good approach. I'm not criticizing it, but I think it's not complete.

18:33So when we bring up to the regulation point to this default fund design, I think the regulations should also consider the impact of economic conditions of people when they are designing smarter defaults. So what I'm trying to say is that I will say UK default funds are necessarily at fault, but I do think there is an important dimension which default design in many countries doesn't fully capture. And this is human capital. So human capital is our largest asset indeed, particularly when we are young. And in other words, human capital is simply the present value of our future earnings. So we are working and we have many working lives ahead of our working life.

19:20But particularly for a young person, the biggest asset may not be their pension pot at all. It's their future earnings and it's so-called human capital. So human capital is also a risk. And I think for smarter defaults, particularly the regulations should consider to integrate human capital risk into design of default funds. So let me give you some example to make this much, much more apparent, this human capital concept. So imagine a 30-year-old with£20 ,000 in their pension. They may have hundreds of thousands of pounds, potentially much more, of future earnings ahead of them. And economically, the present value of these future earnings are an asset, which we call human capital.

20:02But this human capital has risk. So imagine two people who are both 35, age of 35. One has a very stable carrier with predictable income, like a civil employee. The other one works in a highly cyclical industry where employment and bonuses may rise and fall with financial markets. So these two people, even they are at the same age, should not invest into the same financial assets. Because their human capital risk is very different. But when we look at the international experiences of many countries, not only developed funds, also in emerging market countries, we do not see that these human capital risks have been fully captured in the default fund design.

20:47That's right. So I think, yeah, we need to, it's very important. So we need to ask people, not simply asking how old are you in the default fund design. We should ask, what does the rest of your working life look like? so this should be yeah very important critically important in order to design smarter defaults and i think technology and ai would be able to help with that as well because if you then can have someone who can talk more dynamically or input um more dynamically about their you know retirement expectations their lifestyle expectations their earning expectations so that maybe they've got several big financial goals that they're meant to be hitting getting married, buying a house, having a kid, you know, in the next sort of five to 10 years, then those funds could be more aligned to their particular investment need and their strategic investment need, rather than somebody says, well, actually, I can just accumulate for 40 years, I've got no issue, I can just put those in.

21:46And you're right, you know, I think the default fund, it's easy, it's a one size fits all. But unfortunately, it doesn't fit all. And that obviously is a is another risk yes and technology i think can help us to design smarter deports depending on people's working lives i definitely agree your point unfortunately one size fits does not fit so so when we look at the design of target date funds life cycle funds in mexico in turkey in chile we implemented for this life cycle funds in our company for many countries And what we've seen is that when you mimic the U.S. style or U.K. style target date fund, life cycle funds, this does not appear to be consistent with the investment patterns of those countries.

22:34So every country also, depending on their labor income, human capital risk, should have a different default fund design. Even they, for example, do not personalize target date fund design. By country, due to their human capital risk, aggregate human capital risk, they should design defaults differently. Yeah, yeah. No, that makes a lot of sense. That does make a lot of sense. Okay, Seda, thank you so much for talking to us. I think it's really interesting to hear about the three big behavioral biases that we have that could cause risks. Very interesting as well to hear about the technological aspects that we could learn from the platforms, the blockchain, and just increasing people's knowledge about how to use technology to save, especially people in that sort of lower income or irregular income bracket.

23:30I think that's been really, really useful. Seda, unfortunately that's all we've got time for but I want to thank you so much for giving the international experience and bringing the international experience to UK pension resilience so thank you very much My pleasure Simone and thanks very much for having me No problems and for more news and views stay tuned to ftadvisor.com Until next time, take care

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