Build your own Lotus 7 manuals. Photo: Paulo Keller / AUTOentusiastas
Pensions: Financial education is not the answer
Pensions cannot be life long DIY projects as few of us are equipped to make them work.
Forty-five years ago, I bought a Lotus Seven “car” as a self-assembly kit. I knew a lot about cars. I had previously owned a 1940s MG, a Morgan, and a Mini, and had serviced, maintained and repaired them myself. Those schoolroom classes on motor mechanics had been put to good use.
Like the infamous IKEA furniture, it came as boxes of components and sets of instructions. When it arrived, my enthusiasm and satisfaction knew no bounds; big boys’ Meccano, and all mine. Of course, I started to buy all the other toys I might possibly need, the hoists and jacks and ramps and wrenches. It became my sole topic of conversation. My self-view of my financial acumen was confirmed. Because of the car sales tax concession, I was saving loadsa money.
Needless to say, I made mistakes and many parts were assembled, misassembled and disassembled, installed and uninstalled; the use of the hammer grew, almost as much as my curses, while the “car” progressed glacially. That partially constructed thing occupied my garage for over three years; it consumed all of my free time. I came to hate that car and myself for my stupidity. My diminishing circle of friends also came to loathe that car and my impositions upon them for help.
Even when it was complete, it ran like a lemon, and I had to take it to an expensive specialist garage for tuning. Ultimately, I gave up, bought a new MGB and sold the Lotus having driven it less than fifty miles and myself completely mad. My relief was palpable. The cost saving had proved an illusion. It was, in the final accounting, an outrageous expense.
The relevance of this for pensions is that this is precisely what we collectively have been doing to our private pensions; reducing them to lifelong DIY projects, for which few of us are well prepared. We want and need a retirement pension income, and we are prepared to forgo some consumption today to finance that pension. We want to know we have the car to drive in retirement. We really should not need, nor do we want, lessons in motor mechanics or better instruction manuals. This is particularly true as the pension income objective is compound and highly uncertain; both consumption smoothing and longevity insurance.
Those who believe that the answer lies in education should read Lauren Willis’s 2008 paper: “Against Financial Literacy Education”. The abstract of this is damning:
…This education is widely believed to turn consumers into “responsible” and “empowered” market players, motivated and competent to make financial decisions that increase their own welfare. The vision created is of educated consumers handling their own credit, insurance, and retirement planning matters by confidently navigating the bountiful unrestricted marketplace.
Although this vision is seductive, promising both a free market and increased consumer welfare, the predicate belief in the effectiveness of financial-literacy education lacks empirical support. Moreover, the belief is implausible, given the velocity of change in the financial marketplace, the gulf between current consumer skills and those needed to understand today’s complex non standardized financial products, the persistence of biases in financial decision making, and the disparity between educators and financial-services firms in resources with which to reach consumers.
Harboring this belief may be innocent, but it is not harmless; the pursuit of financial literacy poses costs that almost certainly swamp any benefits. For some consumers, financial education appears to increase confidence without improving ability, leading to worse decisions. When consumers find themselves in dismal financial straits, the regulation-through-education model blames them for their plight, shaming them and deflecting calls for effective market regulation. Consumers generally do not serve as their own doctors and lawyers and for reasons of efficient division of labor alone, generally should not serve as their own financial experts. The search for effective financial-literacy education should be replaced by a search for policies more conducive to good consumer financial outcomes.”
Surprisingly, in view of the ABI’s recent negative responses to the proposed introduction of collective defined contribution schemes (CDC), the efficient pension solution does lie in insurance, though CDC is only one step on the right road.
Mary McAleese, the former President of Ireland, put the case for insurance rather well:
The certainty and confidence that insurance provision brings to all our daily lives, whether business or personal, enables us to breathe more easily, to find the confidence to let innovation flourish and to engage with the present and the future, chastened by the past but not allowing the fear of the possible to paralyse us in the present.”
For pensions, this amounts to buying the car, not the kit.
For those who would like to believe that our existing methods might work, if only we applied more of them, let me take just one, transparency, among many possible and indicate its failings. The demands for disclosure and transparency arise from the desire for public accountability – but it is never a sufficient basis for delivering this. Sufficiency would additionally require adequate and unambiguous communication. Moreover, in many circumstances, transparency is not even a necessary condition; notably where it creates perverse incentives.
Transparency and disclosure will not level the playing field between the institutions and individual investors. The institutional investor’s advantage does not lie in simply having access to more information, but mainly in analysis and information processing. That means that greater disclosure will make the gap between institutions and individual consumers bigger, rather than level the playing field.
The further problem with additional disclosure is that it affords even greater opportunity for liability evasion on the part of managers and advisors. All that unintelligible fine print, and those incomprehensible reports are designed to eliminate accountability, and with that any possibility of reparations or redress.
The challenge for the UK insurance industry is to design policies that can provide occupational pensions cost effectively, while satisfying McAleese’s earlier confidence, certainty and comfort principles.
Of course, those innovations need not, and probably will not, rely upon either the nostrums of academic finance or the fads and whims of the omnipresent, omniscient pension consultant. Given the global pre-eminence of London in insurance, it is surprising that Germany and Sweden have more advanced offerings, which have survived the tests of time and customer satisfaction rather well. Another case of vorsprung durch technik?