5  Discussion

The central policy question that underlies this analysis of the HSS is: would more widespread use of workplace superannuation schemes increase the total level of retirement wealth of participants?

This question can be broken down into two parts:

1. Would the current level of participation be increased by some policy intervention?
2. Given that a person has made the decision to participate, does belonging to a workplace scheme lead to a net increase in retirement wealth?

The HSS offers no guidance on the first question. It is possible that through making information available about workplace schemes more employees might be encouraged to sign-up. This assumes that the private providers of superannuation schemes are not offering an adequate level of information at present, an argument which might be difficult to sustain. However, there is evidence that offering the scheme as a default to new employees who would have to write a letter requesting not to be included, may raise the participation rates (Sunstein and Thaler, 2003). Beyond that there is the Australian model where participation is compulsory (Drew and Stanford, 2003).

It may be that because of myopia, people do not in fact save at the rate which would allow them to smooth their consumption through retirement.[10] Only when they eventually retire will they realise that they should have saved more. It is conceivable that by being enrolled as a default in a workplace scheme with automatic payroll deductions, the transaction costs of making a conscious decision to open a retirement account and then meet voluntary monthly payments could be reduced for some people.

Thaler and Benartzi (2001) argue that employees have difficulty making adequate savings commitments and hence save at a level which is less than that which they will subsequently desire.

The employees who fail to join the plan, or who participate at a very low level, appear to be saving at less than the predicted lifecycle savings rates. Behavioral explanations for this behavior stress bounded rationality and self-control and suggest that at least some of the low-saving households are making a mistake, and would welcome an aid to help their saving decision making (p.1).

They propose a scheme whereby people commit in advance to allocate a portion of their future salary increases toward retirement savings. Their key findings are: (1) Most people (78 percent) who were offered the plan elected to use it; (2) virtually everyone (98 percent) who joined the plan remained in it through two pay raises, and the vast majority (80 percent) remained in it through the third pay raise; and (3) The average saving rates for SMT plan participants increased from 3.5 percent to 11.6 percent over the course of 28 months. They conclude that the results suggest that behavioural economics can be used to design effective prescriptive programs for important economic decisions.

Further support for the importance of the design of a savings plan comes from Choi, Laibson and Madrian (2004) who report on experiments with the 401(k) plan offered in the USA under different conditions. When left to decide whether to enrol, in one trial 90% of employees opted not to. However, where they had to make an explicit statement to avoid being enrolled automatically, only 30% failed to enrol. While employees often felt that they could not save more at present, most would agree to save some or all of any future pay rises. In a final experiment the author’s found that if employees were given the option to enrol with no deadline, two thirds failed to ever enrol. In contrast, if a deadline was imposed two thirds actually enrolled. They conclude:

We assess the impact of 401(k) plan design on four different 401(k) savings outcomes: participation in the 401(k) plan, the distribution of employee contribution rates, asset allocation, and cash distributions. We show that plan design can have an important effect on all of these savings outcomes. This suggests an important role for both employers in determining how to structure their 401(k) plans and government regulators in creating institutions that encourage or discourage particular aspects of 401(k) plan design.

Results from a New Zealand survey by ACNeilsen[11] in 1996 showed that 57% of eligible employees were enrolled in a workplace scheme where this was offered by their employer. In the case of firms not offering a scheme, 58% of all eligible employees said they would participate were such a scheme to be offered by their employer.

We now turn to the second question posed at the beginning of this section. Even if the participation rates were to increase, it does not follow automatically that the new enrolees will accumulate more retirement wealth than that which they would have had in the absence of the scheme. As a starting point one could argue that if people pursue a consumption smoothing objective over the life-cycle, then they will have a target level of saving that they consider necessary to provide an adequate retirement income (Gibson and Scobie, 2003). Assuming there are a number of savings vehicles on offer they will choose those which offer their preferred combination of risk, expected return and flexibility. Were they to enrol in a workplace scheme, it is possible that they would simply adjust the level of savings in other vehicles such that their total rate of accumulation would remain virtually unchanged; ie, in the extreme there could be complete substitution, with no increase in total retirement accumulation. In practice, we would not expect to observe complete substitution as the risk and return properties of different savings vehicles are typically different, implying they are less than perfect substitutes.

The results of this study do, however, provide a fairly solid results on the question of substitution. It was found that couples in which either partner has a workplace superannuation scheme, have a significantly higher level of total net worth, by almost $90,000. In addition it is found that the median value of holdings by couples in a workplace scheme is around $40,000. This suggests that couples in which a partner has a scheme have chosen to accumulate funds in workplace superannuation without making comparable reductions in other forms of saving. Their median holdings in other forms are in fact comparable to those who have no workplace scheme.

Some caution is needed in drawing policy conclusions from these results. Even in the case where those having a scheme have higher total net worth, this could reflect a self-selection bias. In other words, amongst the total population there are some with a greater proclivity toward saving (the “squirrel” effect), and perhaps it is them who have enrolled in workplace schemes. Belonging to a scheme per se does not raise wealth; rather, it is the unobservable characteristics associated with those who chose to enrol in a scheme that makes them wealthier. Even in the absence of such schemes it is likely they would have had higher accumulations in any event.

If certain people are “squirrels”, and superannuation schemes are not subsidised, we would expect them to save more than those who lack such a proclivity, other things being equal. However there would be no reason to expect that they would systematically save more in superannuation schemes. Likewise we would not expect the non-squirrels to systematically avoid superannuation schemes. In other words, “squirrelness” would be associated with the amount of total saving, but not necessarily with its allocation. Yet the data from the HSS show that those in a superannuation scheme are higher savers, suggesting that what we observe in the data is not necessarily due to the squirrel effect where schemes are not subsidised.

In fact we know that by definition the workplace schemes did involve some employer contribution, and it would seem that for many people it would be advantageous to enrol in order to capture this benefit. However, we would expect both squirrels and non-squirrels to respond equally to the incentive of a subsidy, with no systematic relation between holdings in a scheme and higher total wealth. But in fact we do observe such a relationship, again suggesting that we can reject the squirrel hypothesis.

A variant of this argument is to note that randomly making a subsidised scheme available in a subset of workplaces (and hence to a random group of employees) means that the variable “holding a workplace scheme” could be interpreted as exogenously given. This would suggest that the causality runs from “holding a scheme” to “higher net worth”, rather than the other way around, in which those with higher net worth sought out a scheme. This would suggest again that ‘squirrelness” is not the underlying explanation of the results.

All the workplace schemes in the survey involve an employer contribution. What might be the effect of these contributions to a workplace scheme? In part the answer will depend on whether the employer’s contribution has a subsidy element which is not offset by reduced wages or other benefits. If there is a genuine subsidy this would represent an increase in the total benefit package. In a survey covering 162 firms and 306,000 employees including 78 of New Zealand’s largest 100 employers (Periodic Review Group 2003) 89% of all employees were in workplace plans that involved a subsidy. 50% of the plans subsidised the fees, 40% provided subsidised life and or disability insurance, and 75% made a contribution to retirement savings.

Employer subsidies can be viewed as equivalent to an increase in the interest rate paid by the superannuation scheme relative to other savings vehicles. Like all changes in interest rates there are two opposing effects on saving. The first is to make present consumption dearer relative to future consumption, encouraging less consumption now and an increase in saving; the second constitutes an equivalent income increase which may lead to higher present consumption and lower saving. Inevitably the net effect is uncertain from a theoretical standpoint. In this study to the extent that workplace schemes offer a higher implicit rate of interest than competing vehicles, there does seem to be some positive effect on net savings. Nevertheless, the role of subsidies is not to be exaggerated, as a very similar pattern was observed for personal superannuation, where schemes are 100% privately funded.

Alternatively, the employer contributions could be in lieu of cash payments so the total benefit package remains the same. In that case it is to be expected that other savings would fall from the lower disposable income to offset the rise in saving through the employer scheme. The end result is that even in the presence of employer contributions there could be total offset.

Another possible explanation for the finding that there is no substitution by those who hold workplace schemes (and in fact there is evidence of complementarity) is that those who joined a scheme did so as a result of financial education in the workplace (Bernheim and Garrett, 2003). Not only did this encourage them to participate in the work based scheme, but it also led to them increasing the savings they made in other vehicles above that which they would have made in the absence of the workplace scheme. This is the “recognition” effect first identified by Cagan.

It is possible that complementarity arises from a desire to achieve a portfolio that offers the optimal balance between risk and return. Having invested in a workplace scheme, the participants chose to balance that investment with additional savings in vehicles which, while offering a different risk-return profile, have the effect of making the risk-return profile for the entire portfolio more in line with their preferences. The net effect is that total net worth is increased.

A further reason for the incomplete substitution, and in fact complementarity, is that some people might follow a hierarchical ordering in their saving patterns, first accumulating funds in a superannuation scheme and then subsequently saving in other forms (property, equities, etc).

Finally, we might expect to observe less than full substitution merely because the characteristics of pension schemes differ from those of other savings vehicles. Attanasio and Brugiavini (2003) identify a number of reasons why in fact pension wealth may not be a good substitute for financial saving in other forms. While their discussion relates to the pension wealth that individuals have in public schemes, their arguments apply in principle to holdings in workplace and personal superannuation schemes. They note that

“…future pension benefits are not liquid and cannot be borrowed against: individuals might be liquidity constrained at some points in time; the implicit rate of return on pensions is not the same as financial savings. In other words, financial and insurance market arrangements (including tax treatment of pension and financial instruments) and different welfare provisions may produce a variety of observed saving patterns and of substitutability results” (pp. 1075-1076).

The illiquidity of pension benefits is less of an issue in NZ where most schemes are either lump sum or allow pensions to be exchanged for a lump sum. However, they are still less flexible than other forms of saving as they are normally not accessible until resignation.