Member Article

How is legislation changing the pensions feedback loop?

The pensions crisis became was a constant background hum of the noughties, as generous final salary schemes closed and it became clear that workers were failing to save adequately for retirement. Auto-enrolment was brought in to combat this, taking into account evidence from pension systems worldwide showing that the number of people contributing to pension schemes increases dramatically if they have to opt-out rather than opt-in.

Two years into the auto-enrolment, as most large and medium-sized companies have rolled out the scheme to their employees, we can see how it’s starting to change the pension savings landscape. And how this change might continue and accelerate as auto-enrolment rolls out to small and micro employers and minimum contributions increase.

How auto-enrolment is changing the pensions landscape

By 2012 British pensions saving levels were at an eight-year low, fuelled by squeezed budgets and savings inertia, the process by which people who don’t save are less likely to start. This was raising the prospect of generations of impoverished pensioners relying on state pension, means-tested benefits and, for homeowners, down-sizing or releasing equity from their homes.

Two years into the roll-out a quarter of workers were still confused about what auto-enrolment meant for them, suggesting that the scheme still had a way to go in dispelling the difficulty many have in understanding how pensions work.

Despite this concern take-up of the scheme is positive and particularly strong among people under thirty. Only one in twenty people under thirty are opting out, defying official predictions which estimated that one in four people in this age group would choose not to enrol.

A recent DWP survey confirms these findings, showing that auto-enrolment and associated publicity campaigns are gradually changing the social norms around pension saving. Since the start of the scheme the survey shows the number of working-age adults who agree that it is a good thing has risen.

It seems that attitudes change markedly once an employee’s company passes their staging date too. The DWP survey showed that once this happens the number of people who say that most of their colleagues will contribute to a workplace pension doubles, while positive attitudes towards pension saving increase.

And it seems that this change in attitudes and social norms is translating to tangible improvements in pension savings levels. Half of working-age adults on lower incomes are now saving appropriately for retirement, up from 34% in 2012, showing auto-enrolment is helping the people that it was designed for.

How feedback loops relate to pension savings

Following the credit crunch it was clear that old, static economic models didn’t work, as they failed to predict or explain the 2008 crisis. Industry commentators are now describing the stock market in terms of a complex adaptive system, described by Nick Armet, a financial writer at investment Fidelity as “a system made up of multiple interconnected elements with the capacity to evolve and learn from experience.”

Image courtesy of Fidelity

Feedback loops are one of the most important aspects of the system, as emergent behaviour constantly adapts in response to information or stimuli transmitted through them. These can either be amplifying (positive) or dampening (negative).

In terms of pensions this system relates both to pensions and the stock market, which in turn affect each other. Positive feedback loops which influence the behaviour and savings habits of individuals include changing social norms and awareness. Negative feedback loops include confusion about how pensions work, pessimistic attitudes towards their value and belief that saving into a pension is not typical behaviour.

Is auto-enrolment changing these?

Briefly, the answer seems to be a clear yes, but in tandem with other changes. Survey data and uptake rates indicate that since auto- enrolment’s introduction positive feedback loops are being increased, contributing the emergence of new patterns of pension saving.

Changes in overall pension legislation in the 2014 budget, removing the need to purchase an annuity, is playing a part too. Research by the National Association of Pension Funds indicates that it is making pensions more attractive to the young and low paid – two groups where auto-enrolment appears to making a considerable impact.

As small and micro employers reach their staging dates it’s reasonable to expect that the increase in positive feedback, and diminishment the negative, will continue. This is particularly so as traditionally smaller companies are much less likely to have a company pension scheme.

This could prompt the emergence of increased levels of pension savings, providing further reinforcement. Again, other factors could stoke this, particularly moves to include retirement savings in calculating the national household savings ratio.

This would double the UK’s average figure, and while some are calling this a ‘sleight of hand’, it would show Britain is not lagging as far behind comparable European countries, as some believe. Improving the image of Britain as a country where people have reasonable levels of savings could create another positive feedback loop.

So not only is auto-enrolment generating self-reinforcing positive feedback itself, it also has potential to work in partnership with other sources of positive feedback to see the emergence of higher levels of retirement saving combined with more awareness and a greater understanding of pensions.

This was posted in Bdaily's Members' News section by Alan Cairns .