Across the globe, individuals are unprepared to act as stewards of their retirement securities. Through lackluster investment performance, misaligned incentives, and inadequate communication, institutional investors have failed to provide adequately for retirees’ pensions and equip individuals to make informed decisions about their retirement. Regulators may need to step into the increasingly severe retirement security gap.
How Is This Research Useful to Practitioners?
Over the past 40 years, defined contribution plans have largely taken the place of defined benefit schemes, shifting the responsibility for retirement savings from employers to employees.
Primarily because of subpar investing results and misaligned incentives, many employers have struggled to fund promises to pay. Many individuals have also failed to save enough. Inadequate returns on insufficient retirement savings mean there is no guarantee of a decent retirement. These issues reflect and affect individuals’ attitudes and abilities to plan for retirement. They also reflect the structure and culture of the institutional investment environment that establishes and manages the mechanisms individuals must use.
In Europe, each nation addresses the pension issue in its own way. The United Kingdom has a centuries-old tradition of occupational pensions. Germany and France have long provided social insurance. Dutch pension plans are some of the best in the world because regulations were strengthened after the 2000 dot-com bubble burst, requiring full funding that helped lead them to the use of liability-driven investment strategies.
Because individuals lack investment skills and are hesitant to save for retirement, there is an obvious need for meaningful pension reform throughout the structure. Behavioral biases and financial literacy are unlikely to improve. Allocating assets and selecting mutual funds are difficult and can be complicated by the type and number of choices offered and the ways in which information is communicated.
Defined benefit pension plans have increasingly struggled to furnish adequate retirement income streams. The hesitancy to fund the plan and the inability of professional money managers to consistently provide sufficient investment returns becomes a problem not only for plan sponsors but also for policymakers. It is unfortunate that asset managers may not always act in their clients’ best interests.
Financial planners and asset managers will find the authors’ conclusions very sobering. Regulators and policymakers face a major challenge to reform pension and social insurance structures.
How Did the Authors Conduct This Research?
The authors draw their observations through a robust survey and integration of the literature on individuals and institutions. Their study pursues several themes.
For the individual, financial constraints, shortsightedness, and the lack of financial literacy result in poor diversification and inopportune shifts in asset allocation—both when saving and investing prior to retirement and when trying to convert assets into a stream of income for retirement. Individuals prefer simple solutions and are vulnerable. Thus, the way financial information is presented to them matters as much as the content of that information.
Financial institutions must meet the liabilities to be distributed in the defined benefit plans they service. There is no consensus about how to allocate assets for underfunded plans.
Underfunded pension obligations and an ill-informed investing public present critical challenges to regulators as they seek to help individuals who increasingly bear the sole risk and responsibility for their retirement. Misaligned incentives that harm investors in defined contribution and defined benefit plans alike can create distrust, causing some individuals to save and invest less. If individuals are “forced to save,” the system should provide incentives for investment managers to act in the individual’s best interest. Any potential solution will have to consider the likely impact on financial markets.
Although the state of institutional and individual retirement plans and options varies by country, the problem of how best to secure a comfortable retirement is a shared one. There are no simple solutions.
The responsibility of retirement planning has devolved mostly onto the shoulders of individual investors, who are ill-suited to the task and face huge risk.
States and firms struggle to meet their pension obligations even with the help of professional investment managers. Institutional investors must grapple with how best to produce returns to meet the promises to pay. Public plans tend to be underfunded.
These issues must figure importantly on the agenda of policymakers and regulators. Investors need a sustainable pension system. They need better education and access to suitable investments and institutional investors that have their best fiduciary interests in mind. All of these changes against the backdrop of large-scale investments and liabilities may be obtainable—but not without significant effects on global financial markets.