Engagement and abstract choices

Why are most members so uninterested in their pension savings? There is plenty of investment choice in most DC pension schemes, but commonly more than 90 percent stay with the default choice. This is not necessarily a bad thing unless you live in South Korea where the workplace pension default is cash.

Our minds have been framed to think about choice in workplace pensions as the ability to select different investment funds. But the practical consequences of selecting a particular investment fund are, to say it mildly, abstract. Since the consequences of choosing between different investment funds are difficult to predict, many consider investment choices to be a lottery with unclear pay-offs and staying in the default seems to be as good a choice as any. There are however, other choices in pensions where the consequences are more tangible. Perhaps these choices, and not the investment choices, are the key to better engagement with members?

Choice architecture matter

The book Nudge, by Sunstein and Thaler, is the reference point for anyone thinking about choice in practice. The authors illustrate the need for a well-designed choice architecture with a default, followed by a limited set of options. Since most individuals will remain in the default, it is important that the default is designed to meet the needs for most savers. An important point in their book, which is often forgotten, is that individuals need to be presented with clear feedback outlining the practical consequences for each of the choices.

Research by B?hnke, Brüggen, and Post, shows that Swedes are largely financial literate. Most know what is important when selecting an investment fund; charges and expected returns topped the list. The least important factor was the name of the provider. When asked about their choices however, they majority only remembered the provider and most did not know if they had an index fund or not. It seems like a conundrum but the answer is surprisingly simple.

The difficulty of making an informed choice between different alternatives increases when the feedback becomes more abstract. If we are not given any meaningful feedback, most of us tend to make a random choice. This is what the participants did, in early television game shows, when they for example had to choose between three similar looking doors hoping to see a car instead of a goat behind the door. When facing a similar random choice in real life, we typically do not make a choice (why bother) or we just pick something that looks familiar (base our decision on the only information we have). This is something that marketers have known forever.

The abstract investment choice

The future investment returns that you will earn on your pension pot have a significant impact on your future retirement situation. The choice of investment strategy is an important decision, but the feedback outlining the consequences for each investment alternative is largely abstract. This is accentuated by the mandatory legal disclaimer – past performance is no guarantee of future returns. In other words, DC savers are asked to pick a few doors among a large number of doors without knowing what is behind the doors. Good luck getting people engaged about that.

Most pension providers have tools guiding us through the investment choice process. Apart from the general advice that a young person should invest in equities (instead of cash), it is difficult provide informative feedback on the consequences of selecting between different flavours of equity funds. Picking one investment flavour over another flavour, will have limited impact on the projected pension outcomes. When including the uncertainty in the projections of future returns, it is not possible to separate the different alternatives.

Perhaps the lack of useful feedback explains why most users are totally uninterested in their pension savings and remain in the default. Given the lack of tangible feedback, this is a fully rational behaviour. Few are willing to take financial advice, which seems rational given that financial advisors must face the same situation when trying to help us select investment funds, and past mis-selling scandals do not help. Advice however, could be useful for avoiding excessive charging structures and becoming more tax efficient.

More tangible choices

Not all of the choices we face in DC pensions are abstract. There are choices with more tangible consequences. It is well-known that when someone hits the magic age of 50, their interest in their pension savings increases. Their life situations including career and family have typically stabilised, the different choices at retirement are limited and the consequences are tangible.

There are also other choices in pensions for which the feedback is tangible, such as changing the level of monthly contributions or selecting a targeted retirement age. It is straightforward to illustrate the consequences of these choices. The absolute impact on somebody’s future pension is heavily dependent on the investment return, but relative increases/decreases are possible to illustrate and that makes it easier for someone to make an informed choice.

Tangible feedback can be given on the consequences of more personal situations. It could be a promotion, working part-time, pa/maternity leave or taking time off to care for a relative. Each of these personal events will have an impact on the pension savings, and it is relatively straightforward to provide feedback on what the practical consequences are.

Rethinking engagement and choice

Perhaps it is easier than we think to get people engaged. Moving away from focusing on abstract investment choices and starting to talk about the more tangible personal choices would be a good start. This implies that good engagement could be someone checking on their pension account every five years or when they are faced with a personal situation.

It seems obvious, but is not going to be easy in practice. Few providers view DC pensions as a standalone business on its own merits. Most pension providers typically view their workplace pensions solution as a distribution channel for their asset management services, and then investment choice is considered very important. As Maslow said in the 60s, “I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail."

The good news is that this provides opportunities for new business models and charging structures that will have a better success of engaging with DC savers by focusing on the choices that do matter to individuals.