• Despite generous state incentives in the auto-enrolment system, opt-out rates are high
• The top three most common reasons given for opting out are high expenses, lack of affordability and lack of confidence in long-term investment 

Introduced in 2017, auto-enrolment reform in Turkey aims to boost accumulated savings in private pension plans, which are currently about 2.5% of the country’s GDP.

Under the current legislation, all employees (but not the self-employed) below the age of 45 years are automatically enrolled into private pension schemes by their employers and required to contribute a minimum 3% of their gross salaries. Employers are not obliged to make an additional contribution on behalf of workers. Despite a stated two-month opt-out period in the system, participants can cancel their membership at any time without any penalties on their contributions. 

Undoubtedly, one of the most striking features of the auto-enrolment system in Turkey is the generosity of financial incentives provided by government. The state matches 25% of employee contributions up to a defined limit and offers a one-time bonus payment of TRY1,000 (€144), which participants are eligible to receive in full at the age of 56 after at least 10 years of contribution. 

Moreover, if workers prefer to draw down their pension benefits in a 10-year annuity there is an additional government contribution that amounts to 5% of the assets accumulated at retirement. 

To date, about 5m Turkish workers have automatically enrolled in private pension plans and the total amount of savings has reached about $700m (€609m). However, despite the high level of state incentives in the system, opt-out rates still exceed 60%. 

Why is auto-enrolment – a behavioural success story in the UK, New Zealand, and the US – experiencing massive exits in Turkey? To understand the main reasons behind this surprisingly high opt-out rate, the Insurance Association of Turkey has prepared a research report using both qualitative and quantitative survey data. The top three most common reasons given for opt-outs were high expenses or indebtedness (71%), lack of affordability (56%) and lack of confidence in long-term investment (35%). 

Although the main reasons for opt-outs seem similar to those in developed countries, Turkey is an emerging economy with distinctive characteristics. Differentiating factors include the presence of a strong state pension system, a young population, fast-growing economy and an underdeveloped financial market structure. Taking these into account, the top three reasons for opt-outs may be further explained as follows: 

High expenses or debt. About half of the working population earns the minimum wage in Turkey, forcing employees to give priority to their immediate needs (such as rent, as well as consumption of goods and services) rather than to save for a distant future. Moreover, despite a low household debt-to-GDP ratio (17.4%) compared with other countries, more than 60% of household debt has a maturity of two years or less, imposing short-term fiscal burden on minimum-wage workers. As a result, low-income earners need larger financial incentives to invest for the long term, compared with high-income groups.

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Lack of affordability. Under the social security programme (including state pension and health insurance), employees and employers are obliged to contribute 14% and 20.5% of worker’s monthly gross wage, respectively. So high contribution rates in state pensions are an important factor in deterring employees from affording an additional 3% contribution for private pension. 

Lack of confidence in long-term investment. In the Turkish private pension system, fund management styles do not seem to comply with long-term investment philosophy. On average, pension plans allocate more than 80% of their assets to fixed-income instruments and the average pension fund has yielded a cumulative annual rate of return less than the average deposit rate over the past 10 years. This is poor performance. Moreover, there are no predetermined default fund offers such as age-based funds for auto-enrollers. Consequently, people have concerns about long-term investment.

To address these problems there are several possible solutions:

Larger financial incentives for low-income earners. To provide relatively higher incentives for low-wage earners, state contributions may be offered as flat subsidies, which decrease with higher income levels. A similar mechanism in Germany-Riester pension plans has successfully increased participation rates among low-income earners. Riester pensions achieve higher coverage rates (13.6%) for low-paid workers, compared with other private pension plans in Germany (4.5%). 

Transfer from public to private pension system. Given high contribution rates in state pensions, a proportion of these mandatory payments could be transferred to the auto-enrolment system. This mechanism would make the system more affordable, as well as decreasing the state’s pension deficit over the long term. Although Turkey has a young population compared with other developed countries, the old-age dependency ratio is forecast to reach the projected OECD average (58.6%) by 2075, which will probably induce further pressure on the government’s budget in the future.

Well-designed default fund options. As lessons from behavioural finance show, most people tend to stick with default options in auto-enrolment plans. Given that, selected default options should offer low-cost, simple and efficient products for pension investors. 

In this regard, government-supported low-cost auto-enrolment plans – such as in the UK NEST and the US Thrift Savings Plan (TSP) – can be attractive for pension participants. Also, age-based funds can provide simple and efficient default solutions with their hands-off investment approach. The portfolio structure of such funds can justify investment in riskier assets. However, their funds’ asset allocation may have to calibrated to deal with high volatility and uncertainty in Turkish financial markets. 

To date, auto-enrolment practice in Turkey seems to be failing in matching other developed countries’ success. However, it is not too late for Turkey to catch up. As already mentioned, to achieve a successful auto-enrolment programme, a system can be designed that is appropriate for Turkey’s socio-economic structure, demographics and financial markets. The Turkish case can also provide important lessons for other emerging economies, such as India and Poland, which have aspirations to offer an auto-enrolment system. 

Seda Peksevim is a PhD student at Boǧaziçi University in Istanbul and a researcher at its Center for Applied Research in Finance (CARF). This year she was the recipient of a grant from the IPE Pensions Scholarship Fund