PEPP talk: Designing a good product for EU citizens

European Insurance and Occupational Pensions Authority (EIOPA) coordinator for pensions policy, Sandra Hack, reflects on the continual evolution of the Pan-European Personal Pension Product (PEPP)

Modern, mobile European careers ask for innovative solutions to address the ever-growing pension gap. New forms of labour, part-time work and times of unemployment, often resulting in low disposable income and small savings, challenge current pension systems and risk inadequate retirement income for an increasing number of European citizens. Private pension savings are adaptable to non-standard, mobile types of labour and can enable reaching the individual’s retirement objective.

The macro-economic environment with persistently low and negative yields in Europe requires re-thinking long-term savings and investments for retirement, in order to deliver on the individual’s needs for retirement income. This entails
outperforming inflation and providing adequate returns for stable future pensions. Long-term pension savings can finance the real economy and so the pension saver can participate in sustainable, long-term economic growth.

For building a Capital Markets Union for Europe, the European co-legislators put at the heart of the initiative the idea of a ‘Pan European Personal Pension Product’ (PEPP), which is designed as a standard ‘default’ personal pension product for the European careers. The market potential of the PEPP had been estimated to reach up to €1 trillion.

What is needed to design a default pension product for Europe?

Standardising key features of pension solutions can have three benefits. Firstly, it can ensure that basic components are designed in a way to safeguard good pension outcomes; secondly, it helps consumers to better understand and to compare and benchmark pension solutions offered to them; and thirdly, it brings efficiency gains and cost savings to pension providers.

Standardised quality features of private pensions benefit both consumers and providers through the realisation of economies of scale, lower costs and an environment fostering both open and fair competition as well as innovation.
Eventually, this is about reaching the right balance in a way that the mandatory standardised elements protect the interest of savers and lower information costs for providers, yet leaving sufficient flexibility and room for innovation.

Cost-effective pension solutions are in high demand in Europe, as the disposable income in many member states is limited and it needs to pay off to save even small amounts. Determinants of high costs in pension products are, in particular,
distribution costs, as well as information and manufacturing costs, which are intrinsically linked to the complexity of products - and the lack of standardisation.

Providing relevant information to consumers, embracing the opportunities of digitalisation, and designing high-quality, enforceable standard product features level out information asymmetries and support the marketing of those products. Efficiency gains are needed, particularly at a time of low asset returns, to build a stronger market for private pensions. Economies of scale and risk diversification contribute to lowering costs and reaping efficiency gains.

Can private pension savings finance sustainable growth in Europe?

Pension providers have the potential to play a central role as drivers of efficient capital markets – as providing genuinely long-term financing, based on long-term savings of their customers. Incentivising long-term financing and investing, so called ‘sustainable investments’ – and their promotion amongst institutional investors – are at the centre of current policy considerations, with the appreciation of environmental, social and governance (ESG) factors as one of the European Commission’s flagship initiatives.

Private household savings rates in the EU have remained at a stable level of 11-12 per cent of disposable income in recent years – and equally stable has been the allocation of household saving to one third to cash and deposits, and another third to insurance and pension products. In order to increase consumers’ participation in economic growth, indirect investments in equity exposures, mitigating the risks of financial loss and establishing consumer trust could be one of the key elements of the solution.

Due to the long-term perspective on investments and retirement obligations, pension providers have developed different approaches to manage the risks for the individual saver to reach good returns and to stabilise the future retirement income. Approaches, such as life cycling or building reserves for a group of savers, mitigate the risks and the effects of market volatility, and therewith enable riskier illiquid and equity-type investments.

Using such risk-mitigation techniques let pension savers participate in the long-term returns of a wide range of asset classes, including, for example, infrastructure or private equity, overcoming individuals’ risk aversion or biases towards avoiding the risk of financial loss. Promoting an inclusive approach to individuals’ investments in the European financial markets may contribute to furthering the efficiencies of those financial markets and to financial stability in Europe.

How to enforce the PEPP’s high quality features

Private pensions often are regarded as an inefficient market, where consumers’ demand is not matched by adequate supply of suitable solutions. Regulation has to address agency conflicts and information asymmetry as shortcomings of an inefficient market. Conflicts of interests need to be acknowledged and the right incentives need to be put in place to facilitate optimised results for consumers. The main tools for enforcing these considerations are a robust regulatory framework, addressing the provider’s governance, conduct and distribution rules, and establishing the necessary supervisory powers to monitor the market and intervene where necessary.

Designing a good product for the European consumer means enabling long-term good performance and pension outcomes whilst setting enforceable rules to monitor the effectiveness. Supervisors need to have in place an appropriate tool set to act swiftly and to – temporarily – restrict or prohibit the marketing, distribution or sale of deficient pension products or schemes. That is particularly sensitive – yet essential – in the financial sectors, and specifically in the pension sector, which is challenged by low consumer trust and high risk of significant negative effects on individuals and their standard of living in retirement – and eventually the financial stability of the sector.

Looking ahead

The growing pension gap creates two challenges for policymakers: making consumers aware of the need and providing for an appropriate framework for valuable and effective private pension products and schemes. To boost the take-up of a private pension product, tax incentives are a powerful tool to encourage consumers to save and to engage with their own retirement objective.

Private pension savings can positively contribute and enable adequate replacement rates in the future, only if the products and schemes are fair and when savings are indeed safe. Safety here is meant as trust enhancing, fair, costeffective and transparently designed with the objective of ensuring stable and superior pension outcomes. At the same time, the pension solutions needs to be sufficiently flexible to cater for a European labour market that is characterised by increasing unconventional careers and heightened mobility of workers. For a European product, it is essential to ensure a level playing field for providers and products, with consistent and transparent enforcement mechanisms at a European level.

Private pension products have to be cost efficient, which can be achieved by reaching economies of scale, and should be attractive to the consumer, addressing behavioural biases like loss aversion. This leads to the need for smart ‘default solutions’, where a standardised set of high quality features is complemented by a few flexible components. Leaving room for innovation and flexibility is needed to help consumers make beneficial life choices and for providers to find superior solutions. Policy and prudential frameworks have to be capable of enforcing such high quality private pension solutions, building on the effective regulation and the provider’s strong governance structures, enabling sustainable private pensions.

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