Engaging people in retirement saving Insights from cognitive
Engaging people in retirement saving Insights from cognitive sciences Nadia Linciano Component Two- 2018 Training Course Financing the social security system in an ageing society: the role of public finance and private supplementary funds Italy, July 1st -15th, 2018 Index Why engaging people in retirement
saving is important How people can be engaged in retirement saving Why standard engagement work? A behavioural perspective Policy actions: Nudging Page 2 may
not Why engaging people in retirement saving is important In a macro perspective, promoting retirement savings may increase national savings favours reallocation of savings into retirement products reinforces the role of private pensions in the provision of retirement income and reduce individuals reliance on public safety net, to the benefit of sustainability of public finances ... support long-term investments and, eventually, long-term growth In a micro perspective, promoting retirement savings enhances individuals financial well-being, their ability
Page 3 How people can be engaged in retirement saving Several policy levers design of pension arrangements tax treatment financial advice for retirement financial education resting on the classic rationality hypothesis To enjoy a similar lifestyle in retirement as in ones working life, individuals use saving and wealth to smooth out income over lifetime Individuals have well-defined preferences on the available choice alternatives that allow them to choose the optimal option (i.e. the option maximizing their benefit) Page 4
The rational agent takes account of all available information, Life cycle theory: planning and saving Source: Hardcastle (2015) Page 5 Why standard engagement may not work? A behavioural perspective The real man versus the economic man (Kanehman, 2012; OECD 2016) Information overload, menu effect and overload Limited attention Rules of thumbs (heuristics) Framing effect, mental accounting, myopia Unstable risk tolerance Inertia or status quo bias
dynamic inconsistency (lack of self-control) choice Information overload, menu effect and choice overload Information overload is the individual incapacity to Page 6 process the information available (either because of Why standard engagement may not work? A behavioural perspective (continued) Limited attention Individuals have a finite amount of attention at their disposal and are often are much less attentive to tasks than they themselves assume. As a result, they may forget things or miss details that turn out to be
important and miss benefits and consequences of options. Rules of thumbs (heuristics) Mental shortcuts that allow to make complex decisions by learning or discovery based on a practical approach. They are not optimal, or rational, but sufficient for reaching a goal Framing effect, mental accounting Page 7 Framing effect: perceptual phenomenon, equivalent Why standard engagement may not work? A behavioural perspective (continued) Unstable risk tolerance: Risk perception and risk tolerance vary depending on framing and mental accounts Inertia or status quo bias
Unwillingness of individuals to change a decision that has already been made even when it is not satisfactory. It weakens the competitive pressures coming from the demand side Myopia Attitude to focus on short-term outcomes, which may be regarded as safer, even when making long term decisions Page 8 Dynamic inconsistency or time inconsistency Further considerations on dynamic inconsistency Present and future rewards versus future selves theories Psychological determinants of undersaving: temporal discounting (present versus future rewards) Want to save for the future but not have the financial means to do so
Present rewards more arousing and emotional than future rewards Not able to project thoughts and feelings into the distant future (people overestimate the degree to which they will feel good about a positive outcome and bad about a negative outcome) Future selves: intertemporal decision making is impinged by conflicts between temporally distinct selves (e.g., a long-term planner and a short-sighted doer) Page 9 Why do people undersave for retirement? A behavioural perspective (continued) As a result of behavioural biases, ... households do not
smooth consumption much over the life cycle ... (Lusardi, 1999) and hence undersave for retirement Need alternative frameworks: E.g., Behavioral life cycle hypothesis, assuming bounded rationality and using the concepts of framing, mental accounting, and lack of self-control (Shefrin and Thaler, 1988) The key assumption of the BLC theory is that households treat components of their wealth as nonfungible, even in the absence of credit rationing. Specifically, wealth is assumed to be divided into three mental accounts: current income, current Page 10 assets, and future income. The temptation to spend Policy actions: Nudging Change peoples behaviour simply by changing the choice architecture, i.e. the way options are presented in the environment
Nudges for savings in workplace retirement accounts: enroll employees automatically use automatic salary escalation to increase contribution rates option of opting out of the plan, change allocations and adjust contributions Automatic enrolment is effective because of inertia (sticking to defaults) default option is perceived as recommended by Page 11 Policy actions: Nudging Pros and Cons Pros: Nudge preserves autonomy because it makes some actions easier to select without restricting the choice set reduces errors and biases by encouraging people to make better decisions as judged by themselves
Cons opt-out policies are based on the inaction of the decision maker: lower commitment to implement the decision opt-out choices are less likely to reflect decision makers' true preferences than will more active choices Opt-out is effective only when there is a single optimal course of action, that most people don't take, and that Page 12 policy-makers identify and favour by making it the Policy actions: engaging (towards awareness in pension choices) Communication is key to boost saving culture and push individuals to take personal responsibility for long term saving Technology can be used to ameliorate communication
and make managing finances easier (FinTech). Pensions industry slow to embrace FinTech, with some exceptions (PensionBee in the UK) Behavioural insights: communication has to be simple, dealing with real, practical event make emotional connections with individuals lives and overtake some stereotypes regarding old people targeted, relevant and contextualized. Communication needs to differ across younger and older workers: temporal construal theory suggests that individuals Page 13 Policy actions: engaging (towards awareness in pension choices continued) Behavioural insights: communication has to rely on proper goal framing, which depends also on the target (young versus old workers) outcome focused approach: people want to
establish a target income in retirement (what do I need?) know where they are against that target know what to do about it if it looks like they might miss it Gamification: people are more apt to change behaviour when engaged in fun, achievement-oriented tasks with pre-set rewards for positive action (used in healthcare) Social norms and make-it-social communication Page 14 References Alemanni, B. (2017), From nudging to engaging in pension, in N. Linciano and P. Soccorso (eds.) Challenges in ensuring financial competencies, www.consob.it Hardcastle, R.
(2015), How can we incentivise pension saving? A behavioural perspective, Department for Work and Pensions, wp no 109 Future self-continuity: how conceptions of the future self transform intertemporal choice Hershfield, H. E. (2011), Future self-continuity: how conceptions of the future self transform intertemporal choice, Ann N Y Acad Sci, 30-43 Kahneman, D. (2012), Thinking fast and slow, Penguin Lee, J. M. and S. D. Hanna (2015), Savings Goals and Saving Behavior From a Perspective of Maslows Hierarchy of Needs, Journal of Financial Counseling and Planning, Volume 26, Issue 2 Lusardi, A. (1999), Information, Expectations, and Savings for Retirement, in Henry Aaron (ed.), Behavioral Dimensions of Retirement Economics, Washington, D.C.: Brookings Institution and Russell Sage Foundation, pp. 81115 OECD (2016), Pensions Outlook 2016, OECD Publishing Paris Shefrin, H. H. and Thaler, R. H. (1988), The behavioral life-cycle hypothesis, Economic Inquiry 26 Page 15 Sunstein, C. and R. Thaler (2008), Nudge: Improving Decisions About
Engaging people in retirement saving Insights from cognitive sciences Thank you for your attention! Nadia Linciano [email protected] Page 16
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