Framing the Add-On Accounts Problem to Maximize Participation

There has been considerable discussion concerning the use of opt-out add-on accounts as a means of increasing national saving.  If one accepts that there are market failures in the retirement saving market, and I do, then the next step is to ask how to solve them.  My preference is generally for market-based incentive regulation rather than government mandates.  In this case, how the problem is structured can help workers make choices that overcome the inherent inefficiencies in the market.  Of particular interest is the “deliberately bad default” which is used to motivate workers to actively participate and make choices consistent with their own preferences (essentially make the bad option more costly than the cost of participation).  But I wonder how well the “deliberately bad default” works for the really lazy worker.  The counter argument is given in the article, "There are no institutional choices that are neutral."  True, but the distribution of costs is worth noting:

Why Do So Many Consumers Choose Frills When Plain-Old Will Do? Pure Laziness, By David Leonhardt, NY Times:  When you cross over the Walt Whitman Bridge from New Jersey into Philadelphia, you are not likely to notice a big change in local driving habits. … Yet if you compare insurance-buying habits in the two states, Pennsylvania starts to look like one big demolition derby. More than half of the state's drivers buy something called a full-tort policy. It can cost hundreds of extra dollars a year. ...  In New Jersey, only one of every 12 drivers signs up for full-tort insurance. Everyone else has a bargain limited-tort policy, which restricts potential damages.  So what, if not driving habits, might explain the great difference? Basic human laziness.  Pennsylvanians who do not sign a piece of paper saying they want the limited policy automatically receive the full-tort one. … This, in the land of social science, is called a framing problem. … the answer you get depends on the question you ask. … "People are extremely passive," James J. Choi, an economist at Yale, said. "They can be pushed around quite a bit, even when there are no formal restrictions on what they can do."  At McDonald's, people buy the combo meal when they might rather just have a small order of fries with their Quarter Pounder. ... For their 401(k), many workers simply accept the contribution rate and the investment choices their company picks for them. In countries where being an organ donor is the default choice on driver's licenses, many more people are listed as organ donors. ...

[S]ome economists have begun making a novel argument. … [T]he more severe and the worse that a default option is, the better off people will be. Only then will they take matters into their own hands.  In many cases, obviously, companies have no interest in changing consumers' behavior. … But a good number of framing problems are different. With car insurance, retirement savings and some other matters, government regulators and benevolent employers can help people make better decisions simply by changing the question that is being asked. … At companies where 401(k) enrollment is automatic, about 85 percent of workers sock away money for retirement in the plan ... When employees have to sign up for a 401(k), only about 33 percent sign up within six months. After three years, the portion rises to more than 60 percent, suggesting that most people do want to save.  … But helping workers save … is not as simple as making it the default option. … This is where the deliberately bad default comes in. If a company set (sic) the fallback savings rate at 15 percent, surely most workers would take the time to make individual decisions about their retirement. A 15 percent bite out of the paycheck tends to focus the mind.  ... But the thing about framing problems is that there is no escaping them. As Mr. Choi says, "There are no institutional choices that are neutral."  No matter what the fallback is, it will attract people. So we might as well at least try to pick ones that maximize - or, at least initially, minimize - our well-being.

Comments

[anne]

Interesting and, I believe, rather accurate.

[james]

has anyone looked back to earlier times when savings participation rates were higher, less worrisome?

what changes occurred to cause people to stop saving?

maye savings vehicles are inappropiate

i remember when savings accouts paid 4-5-5% interest

[Timothy]

When savings accounts paid 4-5% interest, the Fed Funds rate and Discout Rates were both closer to 10%.

As for opt-out rather than opt-in, I don't see an inherent problem with it, but I wouldn't set the default so high. The maximum yearly contribution to a 401(k) is something like 20% of salary and putting the default participation so close to the maxium is going to make people angry once they figure it out. Folks are very, very sensitive about their paychecks and I wouldn't envy the fiduciaries getting phone calls about "where did this $200 out of my first paycheck go?"

Even if that's clearly explained people will forget, the opt-out would have to come up front, and I think the default could reasonably be the maximum that the employer matches. At mine that's 6%, which is what I currently contribute.

I think an oft-ignored truth is that many, many young workers simply don't think about their retirement. Should they? Well yes, obviously, and having grown up with a retirement professional for a father I can't even fathom not saving for retirement, but most of my peers in similar situations don't even think about it. What's more, a lot of folks are scared of the stock market because they don't understand how mutual funds work. And they don't get that over a long time horizon (say, between starting in the job market at 23 and retiring at 70) the particular picks isn't as important as portfolio balance to focus on the appropriate risk level for each stage of life. Obviously the guy two cubes over who's only about 10 years from retirement is going to need a different portfolio strategy than I, as a young person with few assets, do.

Opt-out plans will help with the what, but it can't help people understand why. A lot of companies do investor education, and I think that's more likely to treat the why. I also think that the best thing the current Social Security debate has done is bring retirement planning into people's minds.

[anne]

James

Vanguard bond funds can be looked to for extra yield. For these last 25 years, there was where we needed to be for interest. I expect an argument, but I have no idea why investors who wish to be conservative are afraid of Vanguard bond funds. My family has never used a saving account, and I can not think any of us ever will. Though analysts have been complaining about bonds being too pricey for 15 years, the analysts have been wrong. I do not care however for though I always prefer stock, I am never afraid of Vanguard bond fund movements.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5539&u=4|16|...

Wood-thrush Fledgling
New York City--Central Park, The Ramble.

[anne]

Robert Rubin as Treasury Secretary changed the rules for buying Treasuries so that they could be bought free of comission in amounts under 100,000 dollars; 10,000 actually. But, from my experience people know little about the bond market and waste endless resources in interest bearing bank accounts of various sorts. I think this contributes amply to lower saving rates for bank rates have been so relatively poor, but how you educate people about bonds beyond what Vanguard has done is a mystery to me.

[Lee A. Arnold]

anne, would you do me the pleasure of emailing me?

[anne]

Jared Diamond is on PBS beginning this evening. The programs are repeated, and should be a real treat for all of us. Diamond is the foremost ecological economist we have.

Thank you, Lee.

[Mark Thoma]

anne:

Oregon Birds. The one shown on the first page is the state bird.