Lessons from Behavioral Economics for Public Pension Plans

School classroom with blackboard

Everyone has behavioral biases. Many people have a bias for the present over the future, for inattention and for heuristic thinking (stimulating interest as a means of furthering investigation). Retirement planning is complex with different designs offered— defined benefit (DB) versus defined contribution (DC) versus hybrid plans. Additionally, there are supplemental DC plans and pre-tax versus Roth options. Participants are asked to think about how much they need to save which may be demanding too much of participants in terms of their understanding or willingness to invest time to understand these complexities, especially when procrastination is added into the mix.

As a result of these challenges, one can see certain patterns. There is often a direct correlation between the number of funds and participation. The greater the number of funds, the lower the participation. When asset allocation choices are established, it’s often easier for participants to evaluate fewer options. They are likely to give more weight to the familiar. Diversification is not automatic, there is a preference for the status quo even when auto enrollment or auto diversification is implemented. Options at the beginning of any list are often more highly selected than those at the end and the size of assets or numbers of participants in any option will many times sway the majority to select that option.

There are solutions to overcoming the many biases participants possess. Plans can make fewer options available and pick a sensible default option. It is important to simplify the enrollment process through the use of easy enrollment strategies or the use of target date funds.

Strategies for plan sponsors to remember:

  1. Seek to implement auto enrollment
  2. Differentiate default options (including traditional or Roth, DB invested or not)
  3. Reduce options
  4. Make choices comparable
  5. Offer active choice
  6. Consolidate and simplify enrollment
  7. Exploit existing decision moments (open enrollment, secure retirement week)
  8. Encourage a fresh start (new year resolutions, pay increases)
  9. Offer frequent reminders
  10. Incorporate planning aids
  11. Establish a preference checklist

ACR#269982 12/17