4 minute read 9 May 2023
Businesswoman saving money with putting coins in glass finance

Retirement system spillovers increase success and sustainability

By Josef Pilger

EY Global Pension and Retirement Leader

Passionate about helping governments, providers and members to more effectively tackle demographic transformation. Champion for better retirement outcomes for all.

4 minute read 9 May 2023

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  • Retirement system spillovers increasing success and sustainability (pdf)

Insights from a recent focused and qualitative study commissioned by IFC and conducted by EY teams.

In brief

  • Demographic transformation and aging populations put pressure on the fiscal, economic and political development of many countries.
  • The value from spillovers across the retirement and capital market ecosystem is substantial.
  • The contribution of the spillovers to overall socio-economic and retirement success and sustainability is fundamental.

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Fully funded public and private pension, retirement and social security systems may deliver relief with an often-forgotten mechanism: compounded investment returns. Market statistics show the compounded investment returns can pay for up to 66 cents of every benefit dollar paid in fully funded systems. By contrast, employees, employers, or government budgets pay for all or a large portion of benefits in un- or underfunded systems. This difference demonstrates the need to evolve focus and policy development to maximize success of public and private pension and retirement systems. And it shows the connectivity to capital markets as accumulated retirement-risk capital, spillover effects and compound interest minimize financial demands for stakeholders.

Insights from a recent focused and qualitative study commissioned by IFC and conducted by EY teams indicate far deeper and mutually beneficial socio-economic aspects between private retirement systems, capital markets and socio-economic development through the spillover effects. The interdependencies between funded private retirement systems, capital markets and the wider socio-economic ecosystem can have transformational impact on development and sustainability across many aspects and stakeholders, particularly in developing countries.

About the retirement system spillover research

Public and private pension and retirement research often focuses only on policies and expected outcomes for beneficiaries and the system as a whole. This research, by contrast, focused retrospectively on key observable drivers for success of private pillar 2 (occupational or employment-based) and pillar 3 (voluntary, supplemental and individually funded) retirement systems and their ecosystems in selected, mostly developing countries. As a baseline, EY teams created a systematic balanced and hypothesis-driven “leading practice framework” that covers the ecosystem, capital market and other relevant qualitative, quantitative and stakeholder behavioral context. 

Defining “success” of the funded private retirement ecosystem

Modern funded private retirement systems mostly prioritize adequacy, with less focus on sustainability and integrity as key tenets of system success. A significant focus is on “retirement and directly relevant policy parameters,” and expected rational behavior. Little research focuses on the journey of delivering the policies in practice over decades, the role of mostly private sector providers, the wider ecosystem impacted by accumulation of large long-term risk capital pools and their often-vital secondary impact.

In simple terms, we focused on the spillover effects and secondary interdependencies between funded private retirement system, capital market and the relevant wider ecosystem and stakeholders that impact outcomes and sustainability with their decisions and parameters.

Five key development and sustainability themes

  • 1. Spillover and supercharging effects

    Successful funded private retirement systems accumulate large amounts of long-term risk capital over time. This risk capital is expected to be adequately deployed to improve investment performance and with compound interest create high account balances at retirement. This is the theoretical spillover that characterizes the relationship between funded retirement systems and capital markets. But, in practice this relationship is far more complex.

  • 2. Effective delivery infrastructure

    Successful funded private retirement systems benefit substantially from adequate delivery infrastructure that is both effective and efficient across the ecosystem.

  • 3. Financial literacy, trust, and outcome expectations

    The study discovered almost 100 parameters with varying levels of importance to the overall success of private retirement systems. Many parameters are already well-researched and prioritized while others appear new or surprising in their degree of relevance to practical success.

  • 4. Wage growth trap

    Modern funded defined contribution systems appear to have a structural weakness that has substantial implications for developing countries with rapid and prolonged wage growth: wages simply outpace savings, investment performance and compounding. In the absence of practical alternatives, creating realistic expectations is paramount to achieving confidence, socio-economic and retirement development, readiness, and sustainability.

  • 5. Pillar-1 funding

    Developing countries often carry substantial un- or underfunded government pension and social security promises, benefits, and systems. Comparatively rapid aging and emigration of working residents challenge fiscal sustainability and economic development. This creates a significant temptation trap: tapping into the “piggy bank”, existing funded private retirement asset pools.

Summary

The insights call for creative new collaboration across the ecosystem. New opportunities arise for providers, long-term investors, and international development partners to assist in unleashing the spillover effects more systematically, providing capital to fund necessary infrastructure and supporting domestic retirement and capital markets stakeholders to build better outcomes and sustainability.

About this article

By Josef Pilger

EY Global Pension and Retirement Leader

Passionate about helping governments, providers and members to more effectively tackle demographic transformation. Champion for better retirement outcomes for all.