Choose not to choose
The pensions industry has been struggling with engaging savers for decades. The conundrum is that we welcome policies that automatically enrol everyone into a pension scheme since without this nudge most people would not save for their pension. But then we complain that people do not have strong preferences for their pension savings and they are not keen to actively engage with their pension provider.
The success of auto enrolment explained
All pension experts agree that an opt-out instead of an opt-in approach is an excellent nudge to get people to save for their pensions. Auto-enrolment has been an unprecedented policy success in the UK and there are two explanations for that.
Firstly, we know that nudges and defaults are very strong when the individual’s preferences are weak or non-existent. The majority of people do not actively think of pension savings and if we ask what is important to them, pension savings probably not make it to the top 100 list. Of course, there is an interested minority that are engaged and want to make choices.
Secondly, an equally important reason for the success is that the auto-enrolment policy is in the interest of pension providers. Most communication from pension providers aims at getting people to increase their contribution rates. The industry is positively advocating for auto-enrolment and is generally supportive for policy changes targeting to increase legal minimum pension contributions.
I choose not to choose
For areas where we have weak or non-existent preferences it is often difficult to make choices. As an example, I am not interested in sports. If I was asked to select a cricket team, I don’t have a clue and I am not willing to invest my time and effort in learning about cricket and the qualities of different teams. If I was forced to pick, I would probably pick the local team, in other words actively choosing the default. But for someone with very strong preferences, supporting a particular cricket team is a matter of life and death.
Making decisions have mental costs attached, we need to gather information and seek recommendations from people that we trust. Many people actively choose not to be educated in investment portfolio theory, since they have better things to do with their spare time. Another mental cost is the fear of making an erroneous decision based on incomplete information. Most pension savers assume that the default choice has been carefully designed by someone that is knowledgeable, so it’s considered a safe choice.
The success of auto-enrolment rests on the weak or non-existent preferences that people have with respect to their pension savings. Therefore, in most cases, staying in the default strategy manifests their rational decision of actively choosing not to choose.
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Facilitating choice by reducing mental costs
For those with moderate preferences, a well-designed menu of choices might help to reduce the mental costs associated with making choices. A bad structure will deter them from making choices since the costs are likely perceived too high.
To reduce the cost for gathering information, we need to make the default choice transparent so that everyone can understand what it will lead to. When nudging people to make a choice, the practical consequences of the different alternatives must be communicated in a clear and transparent way. For example, what are the consequences of increasing monthly contributions by 1 per cent?
To reduce the mental cost of making bad decisions, investment choices could be framed as different flavours, or preferences, with similar features as the default. For example a deep green alternative, with a life cycle path that de-risks with age. Of course for those with strong preferences, they should be able to do what they want and we should let them do that.
Financial wellness
There is no point trying to educate people, who have non-existent preferences or are just uninterested. But strengthening the financial literacy for those who are interested could increase the number of people making choices. This could be done through a financial wellness programme which helps members demystify finance and equip them with the tools and information to be in-control of their personal finances. Such programmes could help with prioritisation, in most cases it is better for someone to pay-off their credit card debt before increasing their pension contributions.
Some argue that financial wellness programmes offered by pension schemes should offer additional financial products that members can sign-up for. The motivation is that it significantly lowers the barriers for taking action on their new insights. But there is a risk that such financial wellness tools are seen as a sales tool which then actively disengages people.
Not a nanny pensions state
We need to respect the autonomy of people who choose not to choose, forcing them to choose would be to impair on their freedom. That said, I am not advocating for a nanny pension state. Using nudges in pension communication preserves freedom since it lets people with stronger preferences to make a choice if they want. From a pension design perspective, this will cater to the needs of the majority while still supporting the needs of the minority with strong preferences.
From an industry perspective, this is unfortunately seen as not good enough. The approach for decades has been to use ‘education’ to transform weak preferences into strong preferences but this has had limited success. Many pension providers explore new ways to increase the low level of engagement with members, but it is a bit farfetched to believe a pension fund engagement program will outright transform someone’s preferences.
Low levels of engagement are considered to be bad by almost everyone from pension funds and consultants to pension ministers. But is it realistic to think that we can change the weak or non-existent preferences that most people have for a low interest product? At best, we can reduce the mental cost of making decisions and therefore reach those who are somewhat interested but find it too costly to engage.
Director of Retirement Solutions at Pokojninska dru?ba A pension fund & founder of Irrational Retirement Blog
2 年Good post Stefan Lundbergh and I agree, we can't expect members of pension plans to be very active, when they are auto enrolled and make no decisions about saving, as they are defaulted into target date funds and also their contributions are already set. In Slovenia in most cases employers also pay all of the contributions so even here, there is no input from members. The only time they have to make a decision is when they reach retirement and have to choose how they will decumulate their savings and this will be the next phase that could be “automated”. This is why it's really important we get the defaults right as most members will stick to them or as you put it, choose not to choose. On the other side we also need to be as transparent as possible and have for those members, who would wish to be more active, choices available to them presented as clearly as possible with important things disclosed. The pension/retirement industry needs to get rid of its complex jargon and present choices clearly. Having simple legislation can also help, as just having longer and longer disclosures will also not work, as people just don't read them and we need to layer the information in small clear doses and as personalized as possible.
Gepensioneerd als Actuarial Master at PGGM/PFZW
2 年Dankjewel Stefan, voor dit prima verhaal!
Executive, Supervisor, Actuary, Innovator, Adviser
2 年Thank you Stefan! Moreover: In the first decades of their lives, young people need all the attention and financial resources to realize a job or business with a reasonable degree of income security for themselves and their family. In that context, it is also logical that they are not interested in their far-away pension. From the age of 40, they still have thirty years to save for a good (supplementary) pension. Time enough.. ?? Why all that commotion from government and science to force young people to put money aside for later, while young people at the same time have to take out sky-high mortgages and pay off student loans?