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Europe – Remove the right to opt-out

Mark Sullivan, Fidelity Investments - Head of International Benefits Consulting

It is clear that governments across Europe are looking to address concerns over the lack of retirement readiness of the working population. The concern is well founded with projections[1] showing an ageing population where the ratio of the working age population (those aged 15-64) to the retired population (those aged over 65) is expected to drop from 4:1 to 2:1 by 2060. Contributor Mark Sullivan, Head of International Benefits Consulting.

This has significant implications for social retirement systems and government finances which are already under strain. In response to the financial crisis more governments are evaluating and introducing legislative retirement changes, through a variety of activities including raising retirement ages and passing more of the burden onto the private sector.

Automatic enrolment is one of the strategies which governments and companies are increasingly considering to address the decline in private pension saving. This strategy has been successfully deployed across the globe.  In Australia, for example, auto enrolment was introduced in 1992, and has delivered significantly higher levels of retirement income and reduced the demand on the state social systems. An increasing number of countries across Europe have followed suit and have.

In addition, Germany, Ireland and Lithuania are all at advanced stages of designing auto enrolment plans for launch over the next few years.

It is significant to note that  they have all adopted lower rates of mandatory contributions than experts have estimated are required to provide a meaningful income in retirement. Further, countries like the UK have allowed individuals to opt-out of the auto enrolment plans, potentially leading to individuals choosing not to make any retirement saving resulting in reliance on the state provided benefits.

If current levels of retirement saving are insufficient should governments take a tougher stance on auto enrolment?

As described above, there are two design features which governments could consider to enforce higher levels of retirement saving these relate firstly to the level of contribution, and secondly, to whether individuals have a right to opt-out.

Increasing levels of contribution.

Denmark and the UK have adopted a model where contributions start low but increase over a number of years. Australia adopted a similar strategy starting with an initial contribution of 3% which will move to an ultimate contribution rate of 12% in 2025. The few countries who adopted higher initial rates have only done so when accompanied by a change in tax or social security contributions.

The gradual buildup of contributions enables individuals and companies to plan for the financial impact of any change – this is critical to avoid any unintended consequences of driving individuals into debt it also allows corporates to plan for increases in employment costs. From a political perspective it is easier to gradually increase what many will see as a pensions tax at a time when national austerity measures remain under the microscope.

Experience in countries like Australia and Israel show that gradual increases in contributions, to sustainable levels, are an effective long-term strategy for dealing with inadequate pension provision amongst an aging population.

A number of countries have included the option for individuals to opt-out of the mandatory arrangements. The rationale for introducing such provisions is to reflect that not everyone has the disposable income to save for retirement and compulsion can drive people into debt. There is therefore a strong social argument that a proportion of the population should have a right to opt-out. 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?

Experience indicates that individuals who are auto enrolled in plans do not change the automatic contribution rate – particularly when contributions are accompanied by a company or state contribution. This assertion is supported by statistical evidence published by the UK government[2]. It shows that since auto enrolment was introduced in 2007 participation rates have increased from 60% to 84%. More impressive has been the impact on those industries which traditionally have had the lowest pension participation rates, for example in the Agriculture and fishing industry participation has increased from 18% to 68% over the 5 years to 2017.

This is against a legal framework which allows individuals to opt-out.

Although a 100% participation rate could be the target, in reality there can be very good reasons not to mandate 100% participation if this forces more people into debt. This experience may help inform other countries as they continue to move to encourage greater personal retirement savings without being accused of increasing taxation.

Governments need to tread a fine line in encouraging the population to make adequate provision for their retirement and shifting the burden away from the State. Auto enrolment has a track record of increasing pension participation and deferral rates, and this is evidenced by the increasing number of countries deploying such strategies, and the positive outcomes from those which have implemented such strategies.

Although it would appear that higher rates of initial contributions and removing provision for opting-out could help compel more individuals to save, evidence would suggest a softer, structured approach delivers positive results. However, governments will prudently continue to monitor participation to see if further coercion is needed.

[1] Eurostat, July 2015

[2] As published by the Department for Work & Pensions in the 2018 Pension Participation and Savings Trends report

Fidelity Investments

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