The Role of Financial Education in the Field of Pensions: International and Italian Experience Ambrogio I. Rinaldi Central director, COVIP Conference on.

The Role of Financial Education in the Field of Pensions: International and Italian Experience Ambrogio I. Rinaldi Central director, COVIP Conference on Financial Education Sofia, 29 June 2010 Twinning Project BG/07/IB/EC/02 Commissione di Vigilanza sui Fondi Pensione

Outline The specific challenges for improving financial literacy and empowering members to take appropriate decisions in the pensions field Limits of financial education in the area of pensions, its complementarity with other policy tools, and the need for a consistent policy approach International and Italian experience with financial education and awareness in the field of pensions and with the connected policy tools (pension design and default options, information requirements and selling practices, supervision)

Specific nature of pension issues makes financial education particularly important and challenging… Very long-term Complexity Social relevance large coverage of population pension reforms need to be understood by the public for political consensus Non-recurrent choice (you cannot learn from your own experience) Retirement environment changing much (you cannot learn from your parents)

You cannot learn from your own experience... pensions are different from retail products purchased on a recurrent basis – including financial products typically the savings put in your pension plan should account for a substantial part of your wealth....and you should make a comprehensive planning of their retirement needs since you are young mistakes made when young will reflect heavily on your pensions

You cannot learn from your parents... the retirement environment is changing a lot increased longevity also health and LTC expenses to increase steeply working lives still not adjusting to longevity trend birth rate going down, less workers to sustain retirees public budget stress and decrease in public pensions Diffusion of DC schemes and risk shifting to individuals Individual choice and responsibility

Lack of financial knowledge/ understanding/ awareness/ capability specifically related to pensions : of the changing retirement environment – and the trend for decreasing public pensions of the need to make sound long-term saving plans and to start saving early of the characteristics of different pension schemes and products of the importance and level of costs of long-term investment risks of longevity risks...not only in the general public, but also within trustees / administrators governance issues Yet pensions are poorly understood...

behavioural economics highlight the potential of FE in effectively empowering people to make informed decisions regarding their pensions Lusardi-(variuos years); Lusardi-Mitchell (2007) on the other hand many studies also show the limits of FE and stress importance of institutional design in defining policies in the field of pensions Thaler- Bernanrtzi (2001): save more tomorrow Choi et al. (2002): the path of least resistence Mac Farland et al. (2003): one size does not fit all Role and limits of Financial Education

... with particular reference to DC plans: design of the pension system and and of individual products in order to simplify individual choice Automatic enrolment, default options limits to the number of investment options product standardization Information requirements to plan members and other consumer protection rules (selling practices, etc.) effective competition btw. plans supervision to ensure the implementation of rules and the functioning of the system Financial Education complements other policy instruments...

when wisely designed, default options have an informative and educational value Automatic enrolment: first path-finding experiences at nation- wide level (New Zealand, Italy......UK, Ireland to follow.....) major issues (connected with FE needs): administration and marketing costs, competition btw. plans design of default option (who should set it and how) need to focus FE efforts on issues most relevant in national context need for overall consistency of policy e.g. default options should not contradict FE efforts...Automatic enrolment, default options

International experience on pension awareness and connected issues OECD Pioneering work on pension-related financial education and awareness initiated in 2003; OECD recommandation on Good practices for financial education related to private pensions; developed in 2006 by the WPPP, formally approved by the OECD Council in 2008 Current work on DC pension plans, investment and default options, pension projections and ways to inform members on the uncertainty surrounding estimates (P.Antolìn and others, 2009 and 2010) IOPS Work on information to be delivered to members of DC pension plans (IOPS Working Paper n.5 by Rinaldi-Giacomel, 2008) further work planned EC forthcoming Green paper on pensions will highlight the need for increasing literacy and aawareness inteh field of pensions and the need to mitigate risks beared by members in the funded, DC-based pension regimes through better plan design, regulation and supervision

International experience on pension awareness and connected issues (cont.) major messages coming from the work of international organizations: the complementarity between the different policy tools available for managing risks in the context of DC pensions: financial education appropriate design of products and default options regulation (information to members, selling practices) supervision a consistent policy framework across all the available tools is needed in order to exploit this complementarity

International experience on pension awareness and connected issues (cont.) Some evidence follows on the information to be provided to members of pension plans in a DC context in different countries, regarding: documents to be delivered or made available investment options investment portfolio and returns costs and fees contributions paid pension projections

CountryGeneral description of the plan Specialized document on investments Key developments features/ Members balance statement Personalized pension projection Pension funds annual report AustraliaDelivered at joining AustriaDelivered annually BelgiumDelivery annually Delivered 5 yearly to members > 45 on request to all members (coming) Bulgaria ChilecomingDelivered 4 monthly (1)Delivered annually to members >30 (1) Costa RicaDelivered 6 monthly Hong KongDelivered at joiningDelivered 6 monthlyDelivered annually HungaryDelivered at joiningDelivered at joining (3)Delivered annuallyDelivered annually to members 15 of membership Ireland OPPDelivered at joiningDelivered at joining (4)Delivered annuallyDelivered at joining and annuallyfrom 2008 PPPDelivered at joiningDelivered 6 monthly Delivered at joining and annually IsraelDelivered at joiningDelivered quarterlyDelivered annually ItalyDelivered at joiningDelivered annually Delivered at joining and annually (5) JamaicaDelivery at joining Delivered annually KazakhstanDelivered annually KenyaDelivery at joiningDelivered annually MexicoDelivery at joining (2)Delivered 6 monthly (1) PolandDelivered at joiningDelivered annually SlovakiaDelivered at joiningDelivered 6 monthlyDelivered annually SpainDelivered at joiningDelivered 4 monthlyDelivered annually TurkeyDelivered at joiningDelivered annually UK OPPDelivered at joiningDelivered annually PPPDelivered at joiningDelivered annuallyDelivered at joining and annually Information documents: availability (shaded areas) and delivery

CountryMultiple Investment OptionsDefault OptionDefault option: selected features AustraliaVery frequent AustriaNo BelgiumX BulgariaNo ChileRequired Life-cycle Costa Rica Hong KongVery frequent Usually low risk HungaryVery frequentRequired from 2009Life cycle IrelandVery frequentRequiredLife cycle required for PPP Israel ItalyGeneralizedRequired (OPP)Guaranteed return JamaicaNo (OPP), Very frequent (PPP) KazakhstanX KenyaX MexicoRequired, 2 alternativesRequiredLife cycle PolandNo (PPP) SpainRequired, 3 alternatives (PPPM)Required (PPPM)Life cycle SlovakiaVery frequentReccomendedLife cycle TurkeyVery frequentReccomendedLife-cycle recommended UKVery frequent Required (stakeholder pensions) Very frequent (OPP) Life-cycle reccomended Investment options

Country Investment performance Frequency of disclosure of the actual portfolio Frequency of disclosure of returns Required disclosure of Volatility Publication of comparative tables on the SA web site AustraliaAnnualYesAnnual AustriaAnnualYesNo BelgiumAnnual BulgariaDailyYesX (return, volatility)Annual ChileMonthlyX(returns)Monthly Costa RicaMonthlyYesX (volatility) coming6-Monthly Hong KongAnnualX HungaryAnnual (OPP) 6 monthly (PPP)Yes Annual (OPP), 6 monthly (PPP) SA website IrelandQuarterly and annuallyYesX (return, volatility) Quarterly and annually (PF and SA website) IsraelMonthlyYesAnnual ItalyAnnualX JamaicaAnnual KazakhstanAnnual KenyaMonthlyYes (VAR)XMonthly MexicoDailyX (OPP)Annual Poland6 monthly6-Monthly SpainAnnualNo SlovakiaDailyYesX (volatility)Daily TurkeyAnnualVoluntary UKAnnualYesAnnual Investment performance and actual portfolio

Country Analytical disclosure of all costs Synthetic cost indicator (ex ante) Table fee comparison on SA website Price cap Limits on fee structure AustraliaX X X AustriaX BelgiumX BulgariaX ChileXXXX Costa Rica Hong KongXXX HungaryXXX IrelandXX (PPP) IsraelXXX ItalyXXXX JamaicaX KazakhstanXXX KenyaX MexicoXXX PolandX SlovakiaX X X SpainX X X TurkeyX X (coming) X UK X (PPP) Costs and fees

Paid contributionsUnpaid contributions due by the employers CountryInformation provided byFrequency Warning system in place Activated byCommunication toNotes Australia PFA x Members Austria PFA Belgium PFA Members Disclosure of unpaid contributions within 3 M Bulgaria PFA Unpaid contributions are checked by the National Revenue Agency that collects contributions PFAvailable on website x National Social Security InstituteAvailable on website Chile PFQ x Costa Rica Hong Kong PFA EmployerM Hungary PFA EmployerM Ireland PF6M x PF and Advisors Members Supervisory Authority EmployerM x Israel PFAxPPP management companyMembersPF Italy PFA EmployerM Jamaica PFA Kazakhstan Kenya PFQ CustodianQ x Mexico PF Poland AA Slovakia PFA Available on web-site Spain Turkey PFA CustodianOn request UK PFA Trustee Supervisory Authority Members Disclosure of unpaid contributions within 90 D Contributions

Country How, when made available by PF Assumptions Communication of uncertainty Projectio n linked to I pillar Projections provided on the SA web site defined byInterest rates AustraliaYes AustriaAnnuallyPF and employers To be set according to the Pensionskasse contract/business plan Sensitivity on rates of return: +-1% Voluntary Belgium Every 5 years to members aged > 45 Upon request to all members (coming) not yet defined from 2010 BulgariaProvided by insurance companies on their web-sitePF ChileAnnually to members aged > 30AuthorityOne single interest rate Sensitivity on contribution density Yes Hong KongYes Hungary Annually to members 15 years of membership PF Caveat Ireland At joining and annually (OPP from 01.01.2008, PPP) Upon request to all PPP members PFs Actuary According to guidelines of Society of Actuary A max rate of return (6%) for PPP Caveat Yes IsraelAnnuallyAuthority Assumed rates of return variable in relation to the asset allocation Caveat ItalyTo be made available annually (OPP, PPP)Authority Assumed rates of return variable in relation to the asset allocation Caveat JamaicaAnnuallyPF Mexico Authority Projection to be made using two rates: 5% for all funds and actual return obtained by each pension fund in the last 36 months Caveat SlovakiaUpon request (PPP M, PPP V)Ministry of Finance (PPP M) Assumed rates of return variable in relation to the asset allocation PolandYes TurkeyUpon request to all PPPRegulation Two different scenarios: (9% and 11% before 2013 (6% and 8%, from 2013 ) Sensitivity on rates of return Yes UKAt joining (PPP) and annually (OPP, PPP) Guidance of Faculty of Actuaries and Institute of Actuaries (OPP) Authority (PPP) For OPP: maximum rate of return (7% ) For (PPP): 5%, 7%, 9% Caveat Sensitivity on rates of return (PPP) VoluntaryYes Pension projections

the Italian experience with the introduction of auto-enrolment into pension funds outline of following slides Background information on the development of Italian pension funds since the 90s The implementation of nation-wide auto-enrolment in 2007 The mixed results and the possible explanations Some evidence on the role of financial literacy and pension awareness Policy suggestions from the Italian experience so far

Background info on the development of pension funds in Italy: The start-up Up to the beginning of the 90s, there was no perceived need for pension funds directed to all workers, as 1st pillar was generous: pension funds were limited to high salary workers (managers of large companies, financial sector employees): around 700.000 members, or 3% of the work force. In 1992 (and then in 1995) a major reform of 1st pillar pensions was introduced (including the introduction of the NDC system), that put pension expenditure under control and significantly reduced future benefits (although with a long transition phase). The need for the diffusion of pension funds to all workers (and especially the young) became clear. New legislation, and a comprehensive regulatory and supervisory framework was introduced in several stages from 1993. A system of new pension funds was created.

The start-up (continues) Main features of the system: Pure DC A leading role for occupational, industry-wide pension funds For employers, commitment to contribute linked to labour agreements For workers, voluntary membership Open pension funds (set up by financial, insurance firms) directed mainly to the self-employed, with a residual role for employed workers The first new pension funds became operative in 1998. At the end of year 2000, there were already about 140 new pension funds in place - about 40 contractual, the rest open – a higher number that those still in place. So-called PIPs (insurance-like personal pension plans) were introduced in 2001.

The second phase: the need for a push In 2004, after several years of starting, the system looks well-built in structural terms, but still with low membership rates: around 3m workers, or 13% of work force. After a wide public debate, the automatic enrolment of all employed workers of the private sector was introduced (with the opt-out option), directing to pension funds the annual accrual of so-called TFR (a sort of mandatory severance pay): about 7% of gross earnings. Several other new rules were introduced, mainly with the purpose to increase the scope for competition also in the field of occupational pensions. No specific measures were taken for the workers of the public sector and for the self- employed. At end-2005 the automatic enrolment was planned for the first half of 2008. Then, after the elections in May 2006, the new Government envisaged to shift it earlier, to the first half of 2007. The final decision was taken in late 2006. It was also decided that firms with 50 employees would be obliged to transfer to the Treasury the flows of TFR that workers did not want to be paid into the pension funds.

Nation-wide auto-enrolment: implementation in a hurry With little time available, a rush phase started, implying: The re-drafting of all secondary regulation, to be made consistent with the new law (by COVIP, the specialized regulator/supervisor); the new regulation included specific emphasis to information to potential members The re-organization (by the funds) and the re-licensing (by the supervisor) of the pension funds already in place, plus the setting-up and the licensing of several others A campaign for increasing awareness of general public (by the Ministry of Labour): –all media were used, with special emphasis on TV and radio –dedicated web site and call center –monitoring of effectiveness during and after the campaign Many, capillary initiatives in the workplace (campaigns and meetings) organized by trade unions, often together with the industry-wide funds Detailed information to be supplied by employers to workers at company level Marketing efforts by financial firms commercializing open pension funds and PIPs

The results so far a significant, but still unsatisfactory increase in membership: at end-2009, just over 5m members, or 20% of workforce, 27% of private sector employees (most of the result already achieved at end-2007) Moreover: Very few true auto-enrolled (or silent) workers (at odds with experience of other countries). Auto-enrolment has continued to be in place for new workers, but still with marginal results Membership is very diverse across sectors and funds – mainly depending on firm size and presence of trade unions Participation among the young is particularly low Competition is still weak across different kinds of pension plans. Costs are also very different, and the most expensive products sell well

Membership before and after the TFR reform

Two equilibria : –a good one (role of social parts, cafeteria effect, peer behaviour) –a bad one (little and distorted information) Contractual pension funds: membership rate and firm size

The structure of the pension funds market in Italy

Cost competition in the market for occupational plans 5 years time horizon

Cost competition in the market for personal plans 5 and 35 years time horizon

Explaining the results Structural and objective factors: Low financial literacy and pension awareness among workers to start with Saving (in terms of contribution rates) for pensions is already high – not clear how much room for further contributions For the workers, TFR is a strong competitor vis-à-vis pension funds TFR is good as a source of financing for smaller firms (below 50 employees) – incentives for these employers do not work in the right direction Many workers (particularly among the young) are liquidity constrained. Little room for additional savings Financial and economic crisis: –increases liquidity constraints on potential members –increases need for financing for smaller firms –increases risk aversion, diminishes confidence in pension plans investing in financial markets

Explaining the results (cont.) Implementation factors: Hurried introduction of auto-enrolment: insufficient time to create awareness Insufficient effort to improve awareness on the decrease of 1 st pillar pensions in the long run, with some uncertainty about the further measures that may be introduced regarding pension funds, some aspects of legislation (e.g. taxation) are complex and difficult to communicate Unclear public support for the TFR into the pension funds: appetite by the Treasury for the TFR of larger firms

Explaining the results (cont.) Implementation factors: (cont.) Conscious adhesion, or adesione consapevole – the importance to choose - was the main theme of the awareness campaign by the Government and trade unions – more consistent with voluntary enrolment than with the paternalism that should be implicit in auto-enrolment - some evidence that the campaign did favour the opting out No true auto-enrolment: filling a form has been made compulsory to certify non-action. In terms of contribution rate, the default is sub-optimal for the employee (as it does not provide for the employers contribution, but only for the TFR) In terms of investment option, the default is also sub-optimal for most members: a very conservative, guaranteed investment line

Explaining the results (cont.) Specific issues for personal plans: Despite efforts made through information requirements, strong information asymmetries between selling agents and potential members are still there Application of rules of conduct regulation taken from MIFID is not very helpful: clustering of clients through questionnaires and the resulting characterization of products as suitabile/ appropriate do not address costs, and do not deal with excessive risk aversion Cost of the productAge of potential member Exposure to equity risk Usual MIFID characterization highyounglow or nilappropriate higholdnilappropriate lowoldlowinappropriate A few examples : Specific information mechanisms may be needed for pension products in order to make competition work (e.g. comparative information, etc.)

Questions on financial literacy % of correct replies Entire sample PF members not PF members Compound interest rate53,5%59%52% Inflation perception48,5%53%47% Difference btw. stocks and bonds49%55%47% Risk diversification53%61%51% Relationship btw. price/yield of bonds11,4%12,9%11% Sample size981224757 Some evidence on financial literacy, pension awareness, and the decision to adhere In June 2008 COVIP commissioned a survey in order to better understand the factors influencing workers choices regarding pension fund membership (telephone interviews of about 1000 employed private sector workers) The classic Lusardi-style questions were included: Replies are in line with those of other countries and show a positive (though small) effect of financial literacy of the decision to adhere

Questions on awareness on pension reform (NDC vs. earning-based system, etc.) % of correct replies Entire sample PF membersnot PF members Your benefits will depend: only on the contributions you pay / only on your salary as an active worker / on both / DNK 28,5%32,6%27,2% How large you expect your benefits to be in terms of your last salary: 80% / DNK 63,3%70,1%61,2% The PAYG system (sistema a ripartizione) is a system where contributions paid today are used for: Paying current retirees / paying future benefits to current active workers / both / DNK 37,2%44,6%35% Sample size 981224757 Some evidence on financial literacy, pension awareness, and the decision to adhere (cont.) A few other questions were also asked: Replies show a positive effect of pension awareness on the decision to adhere Preliminary results of econometric analysis through probit models show a stronger effect of pension awareness vs. financial literacy on the decision to adhere

Policy suggestions from the Italian experience so far Ensure consistency between education efforts and other policy tools clear communication on effects of 1 st pillar reforms is essential (orange envelope, etc.): cfr. OECD Recommendation, par.2: promote understanding of the changing retirement environment default options are a strong way to convey education/advice; avoid sub-optimal default options that may contradict education efforts policy design should create a incentive-compatible environment (e.g. making pension fund membership of workers at least neutral for employers / Treasury) competition across pension products may be greatly helped by financial education, but also needs specific devices (e.g. comparative information, etc.) Mitigate the high risk aversion induced by the financial crisis Risk appetite is highly procyclical, make use appropriate investment default options (e.g. life-cycle, target funds) that help educating members to have stable, long term orientation and an appropriate exposure to equity risk

Policy suggestions from the Italian experience so far (cont.) Find the right balance of responsibilities between the State (legislation), social partners and individuals. Soft paternalism, nudging, is useful to complement information and education efforts directed to individuals One size does not fit all, but do not escape the responsibility to advice (trough appropriate default options) what is likely to be the best for the average worker

Thank you for the attention! for comments or questions, rinaldi@covip.it

The Role of Financial Education in the Field of Pensions: International and Italian Experience Ambrogio I. Rinaldi Central director, COVIP Conference on.

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The Role of Financial Education in the Field of Pensions: International and Italian Experience Ambrogio I. Rinaldi Central director, COVIP Conference on.

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