Increasing mandatory pension contributions can lead to higher overall saving levels, analysis from the Central Bank of Iceland has found, with no evidence that savers would materially reduce their voluntary savings in response.

The research was primarily based on saver behaviour following the major 2016-18 Icelandic pension reforms, which raised private employers’ contribution rate by 44 per cent (from 8 per cent to 11.5 per cent per cent) in three stages.

In line with this, the research identified a 'treatment group', which included those households whose total mandatory contribution rate to occupational pension funds was below 13.75 per cent in 2015, whilst others were put in a control.

This showed that whilst the average yearly mandatory contribution rate of the control group was stable of the period, that of the treatment group "evidently rose" over the period.

However, the voluntary saving rate of both groups moved in tandem both before and after the reform, with no indication of a structural break after the pension reform.

This resulted in a narrowing gap in total saving rates between the two groups.

In particular, the research showed that the voluntary saving of both groups rose as the economy recovered from the financial crisis but declined in 2018-2019 as growth slowed.

The report also noted that, as the reform took place in the fully funded occupational pension system rather than in the pay-as-you-go(PAYG) social security system, the rise in household saving translates into a higher saving rate for the economy as a whole.

However, the evidence did not suggest that workers are taking a rational and forward-looking approach in their savings behaviour, but that savers were broadly unaware of the reforms or unengaged with their pension savings.

The report stated: "We attribute the findings to lack of awareness about the reform and limited responsiveness to the reform, even among those who appear to have known that their mandatory saving rate had increased and those who aim to have a buffer stock of savings, and low-income, liquidity constrained households.

“Although non-liquidity-constrained, older, university-educated and higher-income households seem to partly offset the effects of the reform by reducing voluntary saving, the crowding-out effect is close to zero– and well below the full crowding-out predicted by conventional theory."

The survey results supported this, revealing that only around 26 per cent of respondents answered correctly that the employer contribution was between 9 per cent and 13 per cent of wages.

In addition to this, when asked about changes in the employer contribution in the past six years, 36 per cent of the treatment group responded -correctly-that employer contribution had increased, while 25 per cent of the control group
incorrectly thought that the contribution had increased for them too.

More broadly, the survey found that a "striking" 21 per cent of the control group and 31 per cent of the treatment group did not save in addition to their pension saving.

In addition to this, the research found that 7.5 per cent and 12 per cent of public and private sector workers, respectively, say that they have a certain amount in mind that they want to have saved at a certain time.

The survey also looked at savers motives for saving, revealing that saving for retirement was the main motivation for just 15 per cent of respondents.

The Central Bank of Iceland suggested that these findings could have important policy implications, stating: "It is now widely accepted that a well-designed pension system requires a combination of public (pay-as-you-go, defined benefits) and labour market (funded, defined contributions) pensions.

"Indeed, occupational pensions are critical to avoid a sharp fall in living standards after retirement (consumption smoothing), which requires a high level of saving before retirement.

"Our findings bring comforting evidence that it is in fact possible to raise aggregate saving by expanding the second pillar of the pension system."

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