Pension Innovation – Stefan Lundbergh on an admin revolution waiting to happen | AgeWage: Making your money work as hard as you do
Pensions administration is probably the least glamorous part of the pensions industry. It is far from the headlines of the latest sustainable investment strategy, and individuals who thought that accounting was too exciting are over-represented among its workforce. But it is also a place where innovation, that has the potential to change the foundations of our entire industry, can take place.
Administration of pensions is all about collecting contributions, ensuring that you know who everyone is; where they live; execute changes between investment funds; pay out pensions etc. In countries with a weak public IT infrastructure, tracking and tracing individuals is expensive as it involves manual labour. In addition, most savers have several pension pots spread across different pension providers. This means that administration costs are multiplied across the providers, creating inefficiencies across the entire pensions ecosystem.
The Latin American Challenge
I recently learned about an intense policy discussion in Chile, which is focused on how to reduce friction and increase efficiency across the pension system. The government is getting involved as they view the workplace pensions as an extension of the social security system – it is a mandatory ‘self-financed’ complement to the state pension.
To address this non-productive cost drag, one line of thinking in Chile is to centralise the pension administration system, and have it operated by a government agency. Another line of thinking is that the administration cost is going to fall dramatically as a result of new technology, so the problem will take care of itself. This is the classical centralised vs decentralised discussion. Unfortunately, the best path forward is not always clear and most solutions requires some government involvement. Let’s have a closer look at two extreme cases.
Proponents of a centralised solution often refer to the Swedish Premium Pension (which is part of the state pension) as an example of a centralised model. The Swedish Pension Authority hold the central ledger and the saver is free to choose from a vast number of mutual funds provided by external providers. By definition, implementing a central ledger solves both the small pot and lost pot problems and it also doubles as a pensions dashboard. For savers that wish to switch between different providers of investment services, the administrative friction is reduced.
Proponents of a decentralised solution argue that modern technology, such as blockchain, make it possible to implement a decentralised ledger. This would solve the administration problem and create a base for both product and service innovation that goes beyond what we have seen with open banking. This is an interesting idea that is worth exploring a bit closer.
Industry innovation requires standardisation
Looking back through history, standardisation across many different systems has enabled major steps forward. Metric and imperial standards were literally the nuts and bolts of the industrial revolution. With a common standard across all producers, it was easy for challengers and innovators to create new types of machinery by combining existing components. Standardisation effectively lowered the bar for innovation since all nuts and bolts had the same thread. This meant that companies no longer had to be vertically integrated in order to deliver new and innovative machinery.
The value of block chain technology can be unlocked when there is a standardisation of the protocols around a decentralised ledger. With a national standard, specialised providers can emerge focusing on a specific part of the value chain. This will significantly lower costs and open up the market to new services and business well beyond our most vivid imaginings. Moreover, a decentralised ledger can solve many data governance problems. All pension data relating to individuals is the property of each person and stored in the decentralised ledger.
But there are as many possible standards for a decentralised ledger as there are companies interested in developing it. For this vision of the future to materialise, governmental interventions must establish a national standardisation of the protocols behind block chain technology for pensions (ideally for financial services). Strong nudges are required to encourage all providers to adhere to the standard. But without government interventions, progress will inevitable be limited for the foreseeable future.
Building Back Better…
Of course, the pensions administration challenge is not confined to Chile. Despite the United Kingdom’s large financial sector and professional pension industry, the nation has a surprisingly underdeveloped public IT infrastructure. For a start, there is no unique identifier for someone staying in the UK. National Health Insurance is the closest, but that is not a unique identifier. There is a passport number, but not everyone has a passport, and it only valid for 10 years. The list of challenges goes on!
At first glance, it seems strange that Stockholm, a relatively small city geographically located in the periphery, is able to compete with London as THE top European hot spot for tech start-ups. Perhaps the fact that each person in Sweden has a unique identifier and that the public IT infrastructure is well developed has something to do with it?
Highly complex and expensive physical infrastructure projects, such as the new Elizabeth line in London, tend to find their way through the public decision processes. But it seems difficult to initiate equally important, yet much cheaper, digital infrastructure projects such as developing a standard for a decentralised ledger. Access to a modern digital infrastructure would transform the pensions industry, create new jobs and provide better value for money for savers. This could be an intelligent way of building back better.
Centralised or decentralised?
So what are the recommendations for policy makers? With the risk of sounding like an economist, the simple answer is that it depends. Centralised administration requires the government to set up and operate an effective administration business. The decentralised ledger requires standardisation and access to a vibrant start up scene. In practice, there is a range of solutions between the two extremes, so each country has to find a solution that works in their specific situation. In the long-run, I expect the decentralised ledger to gain ground but until then it might be an idea to focus on improving the public digital infrastructure and explore a centralised ledger.