Pension and insurance: the biggest risk is not making a choice
The need to reduce public debt, combined with an ageing population, is putting pressure on the pension systems of developed countries. This is undermining a pillar upon which, in the second half of the twentieth century, Italian households built their financial security and based their saving decisions. Supplementing future income and protecting oneself against unforeseen events therefore requires increasingly informed decisions.
And yet, it is precisely the most important financial decisions of our lives that we often keep putting off. We compare the price of a flight or a smartphone, but we spend little time on more challenging questions: how much income will we have when we stop working? What would happen if a source of family income were to dry up? How would we cope with serious damage to our home? It is not just a question of knowledge. The future is uncertain and always seems far enough away that we can afford to wait.
This tendency has a name: financial myopia. The costs of saving or taking out insurance are incurred today; the benefits often only materialise many years later, or only if an adverse event occurs. It is easy to regard an insurance policy as pointless when no claim is made, or to view pension savings as money taken away from current spending. Yet we take out insurance precisely against the losses we hope never to suffer.
The first step in financial education is to distinguish between saving and insurance. Saving transfers resources from the present to the future; insurance allows us to share the financial consequences of risks that we might not be able to bear on our own. These are complementary functions. An emergency fund can cover an unexpected expense, but it is unlikely to compensate for a prolonged loss of income or the destruction of one’s home.
Pension provision combines saving and insurance. Saving for retirement means setting aside resources for the years when we will no longer be working. But as we do not know how long we will live, we must also protect ourselves against the risk of running out of savings: this is the insurance function of a life annuity. There is also a collective risk: in a public pay-as-you-go pension system, where workers’ contributions fund current pensions, an ageing population can put pressure on future benefits. Supplementary pension savings allow this risk to be diversified, whilst exposing savers to the risks of the financial markets. However, financial short-sightedness leads us to underestimate these needs. The sacrifices required to save are immediate, whilst the benefits lie far in the future. Postponing decisions about retirement provision can be costly: the later we start saving, the greater the effort required to ensure we have an adequate income during retirement.
