No longer a model model?
Doubts have been expressed about the usefulness of the World Bank’s three pillar model for pension provision and whether it should be scrapped for a two pillar state and private sector provision model. The state would protect against absolute poverty in old age, while the private element would be the result of employer and employee agreement and in
theory would take much of the regulatory pressures away from pension funds. How convinced are fund managers by this scenario?
The model first appeared in a report for the World Bank in 1994, ‘Averting the Old Age Crisis’. The report proposed a three pillar structure. This was largely modelled on the Chilean reform of pensions on 1981, since which time it has provided a blueprint for developing countries setting up their own pensions.
But has the World Bank model outlived its usefulness? Does it really enable the proper function of a public/private sector partnership?
In principle, the model should be comprehensive enough to allow any combination of policy measures In practice, it has been interpreted as one particular arrangement: a publicly managed, unfunded, defined benefit pillar; a privately managed, funded, defined contribution (DC) pillar, and a voluntary private pillar.
This has now come in for criticism, notably by Alan Pickering, chairman of the European Federation for Retirement Provision (EFRP). At a recent conference in Frankfurt, organised by the Centre for Financial Studies, Pickering called for a simpler, two pillar system, with the first pillar provided by the state and the second pillar provided by the private sector.
Pickering says: “We keep referring to the three pillars of the pension system. In future there will not be three pillars but two. I believe that there should be a universal taxpayer-financed, generally unfunded state pension that provides an absolute guarantee against absolute poverty in old age. The state and the taxpayer are best placed to provide that guarantee cost effectively to all citizen whatever those citizens’ earning history might be.
“If the state does that then the private sector is much more lightly regulated because it will not be delivering privatised welfare. It will not be delivering public policy pensions goals that can be far more cost effectively delivered by the state.
“So the first part of a new two pillar pension system is a state arrangement that does no more and no less than guarantee reasonable, universal, flat-rate standards of income in retirement.
“The private sector should then be allowed to do what it does best, and that is to allow employers and employees to be determining the shape of a remuneration package and the pension element within that. Commercial providers should be left to determine what products they want to offer their customers. And it should not be for politicians to impose guarantees on either workplace arrangements or in marketplace arrangements. There may well be a place for guarantees, but those guarantees should be priced either in the workplace or in the marketplace.”
He concludes: “There is an emerging consensus in many countries based on a public private partnership. Public systems deal with absolute poverty while private systems deal, in a lightly regulated fashion, with relative aspirations.”
But this proposal poses questions. For example, should private pensions provision be more far more lightly regulated thanat the moment? Should the private sector be free to sell the products its customers want? More controversially, should private pensions have to meet state-prescribed minimum return guarantees?
We wanted your views – is it time for a type of new public/private partnership, and who should do what?
Among the pension fund managers and administrators who responded to our questionnaire, there is a consensus that the state has an important part to play and that the private sector and the free play of market forces are not necessarily the solution to everything.
A large majority (88%) agree that it is the job of governments to provide an absolute guarantee against absolute poverty in old age through a universal state pension, financed by taxes. Those who disagree see the state as an enabler rather than a provider. One UK pension fund consultant suggests the role of the state is “to ensure that private provision is adequate to provide that guarantee”.
Nor does a state pension provision necessarily have to be pay as you go (PAYG). The manager of an Austrian pension scheme points out that the state pension could also be provided based on a DC system.
We then asked whether governments are best placed to provide such a guarantee to all citizens, whatever their earnings history might be. Here again there is substantial support for the role of the state, with 85% agreeing.
Yet some of our respondents vehemently disagree with such a suggestion. They see the state pension as a confidence trick played by governments on electorates that are unaware of the so-called ‘pensions time bomb’. One pension fund manager observes that “politicians and the electorate prefer to be cheated on. The terms of the state pension are getting worse for the foreseeable future, yet people seem to prefer choosing a system with worsening conditions so long as the worsening factors are not clear to them”.
A question that follows is whether the private sector should have any role at all in the provision of a social security safety net. A majority (62%) think that it is no business of the private sector to deliver privatised welfare and social security: “Social security is financed through taxes and thus provide by the state. It is the tax financed solidarity of a society,” says one pension fund manager
There is less support for the idea that governments can deliver policy pensions goals more cost-effectively than the private sector. Only a minority (45%) think this is possible: “Nobody every really reveals the costs, with ever increasing tax rates and ever decreasing pensions payments,” one pension fund manager comments.
The proposal to replace a three pillar system with a two pillar system envisages a clear demarcation of public and private responsibilities – public pension systems deal with absolute poverty while private systems deal with relative aspirations.
This idea gains wide support (86%), although there is some dissent. One pension fund manager points out that “both pillars could be private, with the state having a greater regulatory role in the first”. Another says that the public/private dichotomy is not inevitable: “Like many things in life, it has to do with education.”
The suggestion that the private sector should be allowed to do what it does best – enabling employers and employees to determine the shape of their pensions package – gains wide support (88%). As does the suggestion that if private sector pensions are to operate optimally they should be more lightly regulated. A clear majority (70%) approve of a lighter touch on the regulatory tiller for private pension plans.
Similarly, 64% of respondents say pension providers in the private sector should be free to decide what products they want to offer their customers, without government interference. One UK pension fund manager adds the rider “provided that the risks are clearly communicated”, while the manager of an Irish pension fund warns that “some oversight is needed”.
On the thorny issue of guarantees, there is a surprising consensus. Three quarters (76%) of the managers who responded to our questionnaire say that government and politicians should not be able to impose guarantees –
for example, minimum guaranteed returns – on private pension arrangements, either in the workplace or in the marketplace.
However, there is some disagreement. The manager of an Austrian fund says: “Guarantees should be an option. On the other hand private providers have a duty to offer ‘default’ products suited to the risk capacity of uneducated workers.”
Finally, we posed the question we began with. Should governments abandon the World Bank’s three pillar model in favour of a simpler two pillar public/private partnership?
This suggestion draws little support from our respondents, with a clear majority (64%) in favour of retaining the model. However, there are a significant number of don’t knows (10%). One UK managers says: “It depends on how much flexibility is in the private pillar for top-up aspirations of individuals. It is also not clear in a two pillar system what happens to the self-employed.”
One pension fund manager has no doubts: “Every good company should have the possibility to do something good for its employees and offer a company-funded pension.”