Overcoming barriers to the development of micro pensions

The limitations of traditional pension systems in serving non-formal population segments

As is well known, pension systems around the world are facing enormous challenges posed by their transformations. The trend towards longer-lived and less fertile societies is no longer a problem only for developed countries, as the rest of the emerging economies, albeit at different rates, are observing a process of convergence. Thus, when we analyse the population over the age of 65 and contrast its changes and variations in different parts of the world, we can see a remarkable leap over the next 30 years. Africa, Latin America and Asia will experience increases in their elderly population of between 130% and 225% by 2050, according to figures from the United Nations (2019). However, emerging countries add to the demographic problem other relevant problems that block the possibility of facing financial difficulties in old age. 

One of the underlying problems is the high level of the informal economy, which in most of the emerging world tends to be the norm, a situation that after Covid19 seems to have become more pronounced (ILO, 2020; Bhardwaj et al, 2021). According to the ILO (2020), informal employment accounts on average for 62 per cent, which can be as high as 88 per cent in low-income economies, 85 per cent in low middle-income countries, and 55 per cent in high middle-income countries. According to the same institution, informal work is as high as 20% in high-income countries. That people do not have a steady and predictable wage base of income to ensure a regular contribution to the pension system. Many of these workers are self-employed and operate outside the control of the state, while those who work as employees also tend to do so "under the table", so there is also no possibility of withholding contributions as would be expected in a traditional pension scheme. There are many factors that explain the high presence of informal economies in the developing world, where, in addition to institutional and control factors, there are serious problems of low productivity that interact with labour markets that are highly costly for those who want to be formal. This, evidently, is deepened by the limitations generated by the low levels of per capita income and, consequently, the fact that poverty rates remain high.

Under the scenario described above, it is practically impossible to talk about building a Bismarckian-style pension system, with monthly or regular defined contributions. This is because one of the main characteristics of workers in these markets is precisely the irregularity of their monetary flows, together with other restrictions such as their poverty. A different kind of innovation for old-age savings is required, where micro-pension schemes could fit in.

The savings potential of the poorest and its barriers

Evidence from several studies in different geographies with high socio-economic complexities confirms the fact that the poor save. Banerjee and Duflo (2011) illustrate different examples in emerging countries. The issue, of course, is that under formal savings mechanisms such savings penetration is very low. What the poor tend to use are other mechanisms, many of them unregulated, such as community savings (Banerjee and Duflo; 2011; Dupas and Robinson 2010). Or, there is also a variant of the savings-investment preference that, for example, exists in Spain in the case of high per capita house purchases in Spain. The poor also show similar preferences, but, given their low purchasing power, they save more on a "brick-by-brick" basis, i.e. by buying building materials little by little in order to build their own houses as they go along.

Although there is potential for savings among low-income earners, these savings tend to be made under particular conditions. First, there is the fact that these savings are earmarked for a concrete and tangible purpose. This contrasts, of course, with pension savings, which imply an iron discipline to counterbalance the present bias of human beings (Milkman, 2021; Thaler, 2015; Benartzi, 2012). Second, closely related to the first, this bias or impatience for the present is more pronounced in low-income people. In fact, Becker and Mulligan (1997) emphasised that the possession of wealth encouraged people to invest and be more patient, which implies that poverty makes impatience more persistent. Thus, thinking about saving for a very long-term goal, such as retirement, would not fit with this level of impatience structural state of mind. This is an aspect that has been found in fieldwork in several emerging countries, which demonstrates the difficulties of self-control that lower-income groups have in committing to savings goals (Nava et al, 2006; Dupas and Robinson, 2010; Banerjee and Mullainathan, 2010).

Third, there is a set of formal barriers that ultimately translate into some form of monetary or transaction costs for the informal worker (Dupas and Robinson, 2010; Cámara and Tuesta, 2015; Schaner, Simone, 2010; Karlan, 2014). These costs are reflected in the administration fees charged by financial institutions, the regulatory requirements for opening a savings account, the difficulties of physical or virtual access to banks, as well as the lack of knowledge of how savings accounts work and the lack of trust in the institutions. 

Finally, there is not only the fact that the savings modalities in the formal world - even more so with regard to long-term savings for pensions - are not adapted to the socio-economic conditions and priorities of the poor, but also that the financial institutions themselves do not see any particular attraction in offering products to these groups. This is mainly because it is very costly and complex for financial institutions to generate economies of scale with small and widely dispersed savings (Cámara and Tuesta, 2015; Hoyo and Tuesta, 2018; Bhardwaj, Khanna and Tuesta, 2020).  

So, in order to think about a pension savings scheme oriented to segments of the population with socio-economic difficulties that are normally working in informal conditions, it is important to identify those barriers or obstacles that can help mitigate the structural problem. On the one hand, there is the issue of generating a long-term savings product that suits their needs. On the other hand, it will also be important for financial institutions to see the economic benefit of offering these products. The latter is important, because in many cases we are talking about a fairly dispersed rural population to which we have to find a way to bring them into appropriate contact without making investments that discourage supply. Then there is another set of issues related to people's confidence in and knowledge of financial products, which may involve important financial education work on the demand side.

Micro pensions: design, evidence and challenges

Despite barriers to savings in the informal sectors, evidence suggests that the poor have a significant (latent) demand for savings (Karlan, 2014). Household surveys indicate, for example, that the poor have a surplus that they use for non-essential expenditures (Banerjee and Duflo, 2007). Similarly, detailed studies of the daily lives of low-income groups document the complexity of poor households' financial portfolios as highlighted by the small irregular flows that are aggregated for household or business investment (Rutherford 2000; Collins et al., 2009). Even when regulated savings schemes do not exist, the poor often keep savings at home, save in informal associative groups and/or in livestock assets (Shankar and Asher, 2011; Dupas and Robinson, 2010). There are also cases of poor people who, in order to ensure financial discipline, are willing to accept low or negative interest rates imposed by savings schemes for the service of having their small deposits held for a period of time and then receiving a one-off lump-sum payment (Rutherford, 2000).

Given that the scarce resources of the poor must meet multiple and highly specific needs, targeted savings for a specific purpose or for a household or life-cycle eventuality can motivate them to save more, provided that an appropriate savings instrument is in place. Field studies indicate that the poor prefer small and frequent contributions, and better if these do not involve travel from home (Rutherford, 2008). Other measures that can help increase the level of savings could also be to design long-term savings schemes that provide a combination of escape valves for liquidity needs but at the same time are balanced by provisions that discourage early withdrawal of funds (Ashraf et al., 2006).

With the above as a benchmark, the challenge is how to move towards a long-term savings product aimed at addressing poverty risks in old age. Thus, the concept of micro-pension focuses on this problem, taking into account that the poorest people have the capacity to save, but knowing that they are small and that, in addition, the basis for generating monetary income is irregular. The aim is to generate a certain base of benefits that will ensure an income in old age. Although the informal segment does not retire in the same way as formal workers do, it is considered important to have the necessary basis to at least mitigate risks such as illness, disability, death or inability to continue working, which are shared by all types of people.

The literature discussion on micro-pension savings schemes is largely based on the life-cycle hypothesis, institutional savings theory (Boyetey et al, 2019) and the behavioural economics view (Thaler, 2015 and Benartzi,2012). These theories propose strategies to avoid poverty after retirement and in old age (Agravat and Kaplelach, 2017). Central to the life-cycle hypothesis (Chipote and Tsegaye, 2014), is the fact that rational individuals maximise their future consumption satisfaction by saving to finance their consumption in retirement and dissaving in retirement. Njunge (2013) highlights the relevance of the life-cycle perspective for micro-pensions and argues that, through saving in these instruments, individuals could transfer purchasing power from one phase of their life to another.

From the perspective of institutional savings theory, Schreiner and Sherraden (2007) postulate that an individual's accumulation of financial assets or accumulation of real assets, leading to income security in retirement, depends on the access, incentives, information, facilities, expectations, constraints and securities offered by institutions. According to Barr and Diamond (2009) they provide safety nets for informal workers to save and avoid the risk of poverty in old age. They remove all forms of barriers that limit informal workers at income risk from participating in the social security schemes of workers in the formal economy (Bucheli, Forteza and Rossi, 2010; Bosch and Manacorda, 2012). Floro and Meurs (2013) argue that the institutional processes of micro-pension schemes improve access to pension products, thereby compensating for gaps in contributory social security, and reduce the vulnerability of low-income and informal economy workers to help them better manage risks and combat economic insecurity (Mukherjee, 2014).

On the other hand, the views of behavioural economics point to the problems of biases or preferences for the present over the future and other problems related to the difficulties that individuals have in saving for pensions, when they even have the possibility of doing so and know that it is important for mitigating risks in old age. Thus, policy designs for pension savings based on incentives or "nudges" aimed at helping to achieve this objective can be used in the framework of micro-pensions. Here, aspects ranging from facilitating savings through design or framing, automatic adjustments, the application of digital solutions or even monetary incentives come into play (Hinz et al., 2012).

Regarding evidence of micro-pension schemes, Beverly and Sherraden (1999) state that informal workers find institutionalised voluntary savings schemes and voluntary pension savings schemes convenient and reduce transaction costs, making them more likely to save in times of financial need. Clancy et al (2006) also point out that micro-pension schemes offer incentives and facilities to encourage saving. In this regard, Schreiner and Sherraden (2007) found that retirement, automatic deposit, tax exemption and rebates have more significant positive effects on pension savings outcomes. Also, both Hu and Stewart (2009) and Kwena and Turner (2013) highlighted the convenience of micro pensions in terms of contribution, accessibility, withdrawal conditions and zero administrative cost, resulting in an increase in savings culture for informal workers, and savings culture for informal workers. Schmidt-Hebbel (2014), in a separate paper, also reported that informal workers find micro-pension schemes attractive and transparent, which increases their confidence and encourages saving to increase their pension funds.

Different countries have various forms of micro-pension systems for the benefit of workers in the informal economy. In China, Hu and Stewart (2009) found that the system has been characterised by a minimum liability as well as a voluntary private pension that attracts many small-scale workers due to the simplification and flexibility features of the scheme. In Bangladesh and India, Goyal (2010) notes that the associated agent model and the Grameen model are the most common voluntary pensions in operation. In the case of Chile, OECD (2013) reports a mix of voluntary schemes with government subsidies and co-sponsored schemes that allow flexibility in contributions and withdrawal conditions, as well as tax exemption on contributions and investment income, contributions and investment income.

A conceptual framework for micro-pensions

The traditional earnings-based approach to mandatory pension savings does not fit the obvious conditions of informal/independent workers: lack of employment contract, irregular income flow, socio-economic vulnerabilities, inability to implement mandatory schemes, etc. Although informal workers have the potential to save - and already do - their savings needs could not be aligned with the characteristics of current retirement savings options (if any). 

On the other hand, from a government/business point of view, interacting with these workers can be costly (e.g. economies of scale), which deters the implementation of potential solutions. But there is huge potential for public-private initiatives if there are solutions that develop a market for voluntary retirement savings.

Bhardwaj et al (2020) illustrate that by 2050 there will be 2.4 billion people over the age of 65, of whom 600 million will be below the poverty line, and another 1.2 billion working in the informal sector who have the capacity to save, albeit not in the traditional way, and who will have no way to mitigate the problems of old age. In other words, only 25% will be receiving a pension in the traditional way. Thus, unless workers in the informal sector save enough for retirement, they will face more than 20 years of poverty. Bhardwaj et al (2020) and Tuesta (2020) find that if a person aged 25 saves US$ 1 per day, an inflation-adjusted pension of US$ 400 per month for 20 years could be achieved by the time he or she reaches the age of 60. 

Another important aspect discussed by Bhardwaj et al (2020) is the high cost to governments of providing a universal pension. By way of illustration, they conclude that a social pension of US$2 a day for the 1.8 billion people excluded from the pension system by 2050 would mean a fiscal cost of US$1.3 trillion. The study contrasts this very high public spending figure with what it would mean, for example, if 10% of informal workers were to start saving US$1 a day. In this case, it would be possible to build assets of US$ 850 billion in just a decade. This is very important, because it shows that there is an attractive market for offering micro pensions, if there is the opportunity and incentive to build the right financial product.

A good strategy for developing micro-pensions would be to integrate a range of services and activities into a single "basket". This vision is envisaged by PinBox Solutions (Bhardwaj et al, 2020), which has developed an integrated product for Kenya and India that brings together a micro-pension component, a liquid savings component, an insurance component and a digital payments scheme.  The micro-pension component is designed to provide a flexible "defined contribution" retirement solution. The liquid savings component allows members of this scheme to access resources to address issues such as savings for children's education, marriage and emergencies. The insurance pillar for risks such as health and death, among others, provides the necessary peace of mind in situations of high uncertainty. And all of this is complemented by a digital payment scheme to save and withdraw resources automatically. 

In the case of Kenya and India, a platform has been developed to integrate different actors who are interested in participating in the micro-pension market, but who do not do so because there are no market incentives to do so. What the digital platform does is to connect supply and demand, where different players can come together to provide the service of collection, asset management, custody, insurance, payment of the pension flow, among others. The platform reduces the transaction cost by enabling different actors at a single point. At the same time, the platform itself allows it to be a low-cost and very useful basis for providing timely information and financial education to the participant in the micro-pension plan. In these two countries, WhatsApp chat is used as a means to join, save and receive information.

Conclusions

In this article we have reviewed aspects that we consider key to the development of micro pensions as a solution to the lack of attention to the risks faced by a large percentage of people in the emerging world. We have highlighted the difficulties that formal pension schemes have in adapting to the socio-economic characteristics of informal workers, including the difficulties of generating a regular flow of income that serves as a basis for long-term savings.

We also reviewed that although there is a potential for savings in the low-income informal segment, these usually require a short term concreteness, so it becomes evident that any pension objective needs to be compatible with immediate liquidity needs under certain conditions, as well as the need to incorporate insurance schemes. Most experiences in implementing micro-pension schemes have shown that they can be successful, albeit still on a small scale. The introduction of digital platforms to reduce transaction costs offers interesting expectations in terms of the possibility of reducing transaction costs to make financial products attractive to both supply and demand, but it remains to be seen how much take-off can consolidate it as a larger scale mechanism.

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