What DC plan member education can learn from behavioural economics.
DC plan sponsors agree: the fortunes spent and rivers of ink spilt on member education do not produce desired results. Many studies say the same thing. For example, a recent publication by the Organisation for Economic Co-operation and Development found strong statistical evidence that educational activities have only a negligible impact on members’ investment decisions.
With DC plans replacing DB plans as the main pension vehicle in the corporate sector, it’s important to ask how the DC industry can rethink and restructure its education efforts. And the first step is to examine why current approaches tend to yield disappointing results. There are many reasons.
1. Plan members are expected to make complex decisions about an uncertain future.
2. Published guidelines (e.g., the CAP Guidelines) are generally not “customer-friendly,” lacking clear purpose and relevance, and presenting industry rather than member perspectives.
3. Plan sponsors may not prioritize the development and delivery of educational programs specifically targeted to members’ needs and interests.
4. Educational programs generally don’t use effective teaching or learning techniques that promote interactive communication through language, style, delivery method and source credibility.
5. Educators fail to recognize the inherent challenge of overcoming limitations imposed by human nature, such as people’s hard-wired biases and heuristics.
Let’s take a brief look at each of these factors.
1) Decision-making complexity – Investment decisions—especially close to and during decumulation—are extremely complex. Plan members have to make assumptions about their future financial needs, longevity, investment returns, lifestyle changes, emergencies and bequest needs—all in the context of uncertainty over a potential 20- to 30-year period. In effect, members are expected to make the same or even more difficult decisions as chief investment officers (CIOs) of large pension funds.
2) Purpose, guidelines and expectations – When designing member education, it’s essential to first clarify what members genuinely need to know and are able to learn. Without an explicitly member-oriented approach, the guidelines merely reflect what wellintentioned DC experts have decided members ought to know and do. Guidelines, by their very nature, are consensus documents from a specific group with varying interests and stakes at a given point in time, so they are necessarily vague and open to broad interpretation. They may even create the belief that in complying with them, the sponsor is following best practices—when, in fact, they’re merely establishing a potentially low benchmark that becomes the gold standard for many years to come.
3) Member education priorities – DC members are usually well looked after until retirement: investment lineups are usually reasonably designed, the number of options has gradually been shrinking, member education is available, and default options can guide more than 80% of members to a welldiversified efficient portfolio at low costs. Unfortunately, much of this support disappears at the decumulation decision— the very point where complexity explodes. Yet 60 cents of every retirement dollar are paid by returns earned after retirement as the direct result of decumulation decisions. Only a vigorous, relevant, timely and behavioural economics-based member education program—coupled with properly selected default options calibrated against expected member knowledge—can make a difference in actual outcomes.
4) Language, delivery and content – Member education materials are usually written in “Grade 15 “ language for members who generally read at a Grade 10 level, with even lower numeracy skills. Coupled with the standard practice of starting decumulation planning just a few months before retirement, it’s hardly surprising that members are overwhelmed and confused by the enormity of the decisions and end up with suboptimal retirement portfolios.
Some leading professionals and academics (such as Don Ezra, Zvi Bodie, David Laibson and Robert Merton, to name a few) have been warning us about the impossibility of training DC members to act as CIOs and have offered a list of requisite concepts that member education should cover. Such concepts should be continuously and forcefully voiced and repeated at every stage of the DC lifecycle so members can take meaningful remedial action in time. 5) Hard-wired biases and heuristics – Behavioural economics helps explain the “hard-wired biases” that influence people’s decision-making. Research findings identify concepts such as hyperbolic discounting of the future (future events are discounted at a very high rate so people tend to make irrational decisions); prospect theory (the pain of loss is felt more keenly than the satisfaction of gains); availability heuristics (acting on what comes easily to mind); and confirmation bias (ignoring information that contradicts already-held beliefs).
For example, behavioural economics helps explain why plan members don’t tend to purchase annuities. Buying an annuity constitutes a “loss of assets” (prospect theory) in return for a longterm secure income stream (stretching over 25 to 30 years)—which, in the retiree’s mind, is “discounted” at a very high rate (hyperbolic discounting).
Education efforts and DC designs that ignore the findings and implications of behavioural economics will likely crash due to innate member resistance. But DC programs designed to address hard-wired biases stand a good chance to benefit members and provide impetus for the development of new financial products.
With little hope of changing human nature or raising members’ reading and numeracy levels, employers may want to rethink their approach—not only to education but also to DC plan design.
Canadian society will produce 1,500 retirees every working day for the next 20 years, and financial institutions have an overriding interest in serving them. As these institutions vie for asset decumulation, competition will result in better financial products and more effective education efforts.
The reality is, some problems just can’t be solved by member education—no matter how well thought-out it may be. To raise retirement incomes, plan sponsors may have to change their DC plan designs using behavioural economics, including in-plan income options, nudges and defaults.
However, tools based on behavioural economics research offer huge potential to improve member education programs, leading to better saving, investing and decumulation decisions.
Let’s hope this potential will be realized in time for the roughly nine million Canadians who will retire in the next 15 to 20 years.
John Por is the founder of Decumulation Institute
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