Europe's future may lie in its pensions

The EU is set to introduce an entirely new class of pension products, according to a proposal by the European Commission currently under debate. Here comes the... PEPPs.

By Alexandru CIUNCAN

Almost one century and a half after Germany's first Chancellor, Otto von BISMARCK pioneered the first public pension system in Europe, the EU Commission is set to introduce the PEPP: Pan-European Personal Pensions. The initiative is said to bring multiple advantages, for both savers, the financial services industry and capital pooling, as set out in the CMU-Capital Markets Union plan.

PEPPs in a nutshell
The PEPP is designed to be a supranational voluntary system of individually funded pensions. In other words, EU citizens can contribute and basically buy more or less the same pension product regardless of their country and without affecting the existing national pensions arrangements, which are anyway very different between countries (The degree in which EU citizens still rely quite on the public pension systems differs from country to country. Some invest in occupational Pillar 2 schemes while others reportedly still share a belief that Governments will always step in and save the day).

In a nutshell: PEPPs are designed to be simple pension products, transparent in terms of costs and fees and, most importantly, portable between Member States. So, if all goes according to plan, one can start contributing to one of the PEPP funds in its home country and still be able to continue saving for retirement when moving to another EU member state, although the exact mechanism that providers would employ in order to allow this to happen is under debate. There are five investment options from which future pensioners could choose from, with a default one for those that either don't care or just don't have the time, patience and skills to look at the fine print.

But there are important issues still up for debate between stakeholders: politicians, insurance industry, asset managers, distributors and, most importantly, future pensioners - the ones that will benefit from the personal pensions. Needless to say, as this is still a work-in-progress piece of legislation there is a lot of value in debating some of the major discussion points.

The PEPP is probably the most tangible outcome of the Capital Markets Union and the first European initiative towards a single pensions market.

What future pensioners really want?
People generally want to have an adequate retirement income when they arrive to that point in their lives. With the low interest rates environment and given the shift from Defined Benefits schemes to Defined Contributions, retirement income is unfortunately not guaranteed anymore. So, it is fair to say that young people expect personal pensions to be safe life-long products that are simpleeasy to understand, transparent in terms of costs and commissions, less bureaucratic, accessible online, portable and that also address the issue of retirement for European citizens, for all of us. On a larger scale, personal pensions should be designed to fulfil the society's needs at a whole.

In terms of limiting factors of the PEPPs success, at least in the newer members of the EU, one needs to look at the still low purchasing power (just look at the household savings levels) in comparison with Western-European countries. On top of that, young future pensioners everywhere don't usually think about retirement and old age. In any case, PEPP Products should offer opportunities for more retirement savings, especially in emerging economies, as well as for cross-border mobile workers, and should offer pensioners adequate retirement income.

We all need to save more
OK. So, what if we have managed to enrich the offer of personal pension products if few potential beneficiaries understand or afford them? Which leads us to another issue at stake: how to encourage people to save more for retirement and, also, how to get younger generations interested in the PEPP? These are extremely important questions, especially given the inverted consumption cycle of pensions, but also since increasing the uptake of pensions require that future pensioners have to understand the need to contribute to a voluntary pension scheme given the falling replacement rates of public schemes and huge demographic challenges, start to save more and earlier than they currently do and, of course, understand what they are buying. Public awareness campaigns at both EU and national level, with best practices and projections of the future, such as testimonials, with concrete examples of how retirement can look like with or without proper savings can also encourage people to save more.

At the same time, we need to see how the PEPPs will be different from other national personal pensions and what other advantages they might bring (maybe used as collateral in credit ratings) etc.

In any case, education is key, alongside technology (e.g. mobile phone apps, social media etc.), in particular for younger generations. In example, mobile phone applications are not only a consultation tool, but they may also be used for communication and engagement purposes. There are already out there apps which helps its customers visualize what their retirement lifestyle will be like, based on their current savings levels, and interact in the social media.

Why trust the PEPPs as products?
In terms of trust, it is the EU labelling that should act as a quality mark. EU-related initiatives are mostly seen as trustworthy, having proper regulation and supervision, governance etc. although bureaucratic. But can this reasoning work in the UK or in The Netherlands? This remains to be seen. Another factor that can contribute to trust is offering transparency in terms of costs/commissions and risks faced by consumers. Consumers truly deserve to be adequately and realistically about their expected retirement income.

Could the PEPP initiative be successful without tax incentives?
Fiscal incentives have played an important part in the development of the pension industry everywhere. Therefore, most experts agree that tax incentives are key to the success of the entire project. In example, if some countries offer tax incentives to Pillar 2 pension products but not to the PEPP, there is little chance that future pensioners in those member states will also invest in PEPPs.

However, deductibility seems to be much more relevant in some countries than in others. In example, there are examples of countries in which tax incentives are mostly relevant to companies and not individuals, hence granting them will not cause a major uptake of pensions, but instead represent a gentle push.

With or without guarantees? What is a guarantee anyway?
As already stated, future PEPP pensioners will be able to choose between five investments options, with a default one available without advice. But how should the default option look like? How to rightfully balance the risk and future returns?

In terms of investment options for the PEPP, it is said that life-cycling and capital guarantees provide different levels of protection. So, there is an ongoing EU-wide debate whether life-cycling investment strategies should be allowed in the default investment option to protect the PEPP saver from potential capital losses? Both insurers and asset managers do their best to support their current positions, with asset managers naturally supporting life-cycling.

In other words, the safety of the capital invested should be the first and foremost priority. However, this should not hinder the flexibility of others, who may feel that their retirement saving should generate a certain rate of return and that are willing to accept to take some investment risk, to choose a more riskier investment option.

Decumulation decumulation decumulation...
A pension product is anything that provides the individual an adequate income when they arrive to the retirement age and that will continue to do that for the entire length of a persons' life. Given that pension saving products aim to provide an income during retirement, protection against longevity risk (i.e. through life-long annuities) should have priority over other forms of out-payments (lump sums or drawdown plans).

However, regardless of the final decumulation system established by the PEPP Regulation, its risks should be very clearly laid out and explained to savers. Consumers should be offered a realistic estimation of their expected retirement income (i.e. don't make promises that are not realistic). Decumulation is a core part of what makes a product a pension product - because it puts the emphasis on saving in order to provide an income throughout retirement. So, the risk of longevity must be covered, as this in the true nature of pension products as opposed to other investment products.

Just how important portability of your PEPP is?
Unarguably, portability is one of the key objectives the initiative sets out to achieve. This can be of great support to citizens moving from country to country. Thus, a compartment-based system is imagined by the draft PEPP Regulation - one that is criticized by many stakeholders and considered unfeasible for an economic standpoint by industry and which could potentially hinder EU citizens in smaller or less developed markets equal access to high-quality PEPP products. So, a solution must be found - otherwise there will be a rift between the offer of PEPPs in Western Europe, i.e., then in CEE and beyond.

All in all, although the compartment-based system currently included in the PEPP Regulation is questioned by many stakeholders - at the end of the day any system that would achieve the above-mentioned objectives and be workable is better than none.

Last but not least
PEPPs are in a class of their own. Standardized Pan-European pension products, authorized by the European regulator - EIOPA and supervised by national competent authorities with a layer of fiscal and, why not admit it, political issues on top. But what is clear is that PEPPs are another step taken in the direction of globalization, a product of the future in so many ways. Will it fly? That remains to be seen...

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