New Policies for Mandatory Defined Contribution Pensions: Industrial Organization Models and Investment Products.

Abstract

This book has three main objectives: (a) to discuss the main implications that consumers’ inability to make rational choices can have on the functioning of second pillars, (b) to describe how jurisdictions have tried to address these problems through ad hoc policy interventions, and (c) to propose new policy directions that potentially could address these concerns more effectively. The common thread throughout the book is the limited capacity of individuals to choose what is best for them.

The book acknowledges the usefulness of financial education programs as a means of improving individuals’ rationality. However, it contends that rationality is in the end bounded and that individuals’ decision-making process will inevitably be dominated by the use of rules of thumb. These heuristic solutions are not rational according to traditional economic theory but are broadly predictable; therefore, they display systematic biases. These biases can be exploited (rather than corrected) by policy makers to design interventions that are more effective at protecting individuals from themselves than are the ad hoc policy interventions that are currently used.

The book provides clear recommendations on new policy directions for exploiting individuals’ inertia and the biases in their decision-making process in order to promote a reduction in administrative fees and an increase in risk-adjusted expected returns over the life cycle. In addition, it provides a clear distinction between policies that can be safely adopted by the majority of jurisdictions and other policies that, while promising, require further research or present more marked trade-offs.

Keywords: Second pillars, mandatory pensions, competition policy, strategic asset allocation, investment choice, default options, life-cycle funds

JEL Classification: L00, L10, L120, L130, L140, L150, L20, L50, D42, D43, G20, G23, D90, D91