A growing number of countries are planning to reduce the strain placed on public finances of providing pensions to ever more retirees by encouraging individuals to make more adequate provision for their own retirement. This is a focus which is being actively encouraged by the World Bank and the OECD, both of which have been vocal about the sustainability of existing retirement systems. Their call to action is resulting in fundamental reviews of the state and supplementary pension systems across the globe.
These reviews are leading to countries to consider adopting strategies to more forcibly require individuals, with financial support from their employers, to save for retirement. Having reviewed existing systems and their relative success, there is an emerging favoured method of choice – the use of auto-enrolment schemes funded with company and individual contributions.
Automatic enrolment retirement plans are not a new concept. It was adopted by several governments, including Australia, which launched its programme in 1992; Israel, which introduced legislation in 2007; and more recently the UK, which implemented provisions in 2012.
In each of these countries, employers, employees or both have been required to make retirement contributions. The level of contributions varies but we have seen the mandated contributions increase periodically from relatively low levels to those which are intended to provide a meaningful retirement fund. For example, contributions in Australia have risen from an initial rate of 3% and are expected to rise to a target level of 12% by 2025, in Israel, the initial rate increased from 1.666% to today’s level of contributions of 12.5% (split 6.5% for the employer and 6% for the employee).
Other countries have reviewed the international experience and have announced plans to introduce similar legislation ensuring workers are automatically enrolled to a company pension plan, with minimum levels of contribution. Figure 1 provides a snapshot of countries that have announced auto-enrolment plans to be introduced over the next few years.
In addition to these countries, several others are reviewing their pension policies to determine whether or not the introduction of an auto-enrolment scheme could encourage individuals to save more. For example, in Germany where there is a long tradition of retirement saving, regional ministers are encouraging the launch of auto-enrolment plans to boost retirement savings for those who are not already enrolled in adequate workplace pensions.
So if auto-enrolment plans are likely to become more commonplace, what are the key elements or features for a successful plan? The two key design features are the rates of contributions and the ability for individuals to be able to opt-out.
Rates of contribution
It is clear that those countries that have adopted auto-enrolment have almost universally looked to increase rates of contributions from relatively low initial levels over a period of time. This is a critical feature in creating a saving culture and moving people to meaningful levels of retirement contribution over a period of time.
Starting with significant initial levels of contributions can force individuals into debt by reducing take-home pay, companies may also struggle in maintaining competitiveness in the global marketplace. Where higher initial contribution levels have been introduced, these tend to be softened through legislative change. For example, in Lithuania, which moved to a 4% employee retirement contribution, this was in large part offset through taxation and social security reform.
However, in general most countries have taken a phased approach which allows individuals and their employers to plan their finances accordingly and minimises the financial shock of change. This policy supports the gradual move of the workforce to levels of contributions which can be expected to provide a meaningful retirement income.
Several countries have included the option for individuals to opt out of the mandatory arrangements. The rationale for introducing such provisions is to reflect the fact that not everyone has the disposable income to save for retirement and compulsion, and an opt-out may stop individuals being driven into debt. There is therefore a strong social argument that a proportion of the population should have a right to opt out. However, the concern is that those who should, and can afford to, save for retirement might elect not to do so. So the question quickly becomes does providing an opt-out lead to significantly lower rates of saving for those who can reasonably afford to make provision for their retirement?
International experience indicates that most individuals who are auto-enrolled in plans do not elect to opt out or reduce their contribution – particularly when contributions are accompanied by a company or state contribution. This assertion is supported by statistical evidence published by the UK government. It shows that since auto-enrolment was introduced, the proportion of the workforce actively participating in retirement plans has increased from 55% in 2012 to 84% in 2017. The impact on those industries which traditionally have had the lowest pension participation rates – for example, in the agriculture and fishing industry – are more impressive, with participation increasing from 18% to 68% over the five years to 2017. This is against a legal framework that allows individuals to opt out. This evidence from the UK is also supported by experience in the US, where auto-enrolment is an active strategy adopted by companies to encourage more people to save for retirement. Our research shows that the employee participation rate in auto-enrolment plans is 87%, against 52% for plans without an auto-enrolment feature – these plans do contain opt-out features.
While existing experience indicates an opt-out does not necessarily reduce savings rates, these need to be kept under review to ensure current experience continues to be replicated.
It is clear the number of countries preparing to launch auto-enrolment plans continues to increase; evidence would suggest that these plans are gradually enabling the workforce to better provide for their own financial security in retirement. As with all policy changes, it will take some time for the benefits of increased retirement saving to be felt across the globe but momentum is increasing.
Mark Sullivan is head of international benefits consulting at Fidelity Benefits Consulting