Boosting Covid-19 vaccine uptake and saving for retirement – same thing?

Since Covid-19 vaccines are finally being approved by regulators in the US, UK, Canada and many more countries following soon, the second part of the battle is just beginning – how to get as many people as possible vaccinated. One might think this will be first a logistical problem, but in reality it’s more of a behavioral problem. Uptake of the vaccines is voluntary, so the first challenge is how to convince people to get them. Luckily many renowned behavioral scientists, like Nobel laureate Richard Thaler, Katy Milkman, Cass Sunstein and the likes, have already come up with interesting nudges to get the job done as fast as possible and interestingly enough many nudges are very similar to increasing retirement savings. 

Kathy Milkman writes in The Economist the challenge is two fold, first people who aren’t ideologically opposed to vaccines need to be convinced to take the shots, and second, we need to make sure people will actually follow through on their intentions. Keeping in mind vaccines need two doses to reach the full effect, although the first dose already significantly improves immunisation. As one of the strategies to increase vaccine uptake Milkman suggests using “social proof” to increase the appeal of getting the vaccine as research shows people look to their peers for cues about how to behave [1]. A great example of this is the fact former Presidents Obama, Bush and Clinton already volunteered to get a coronavirus vaccine publicly to prove it’s safe and this is a living example of social proof in action. Similarly, getting high-profile people to encourage retirement saving has been a long used and effective strategy. 

Milkman also suggests making people getting vaccinated more visual, to encourage others to follow, the same as people get The “I Voted” stickers when they vote people should now get the “I got the Covid-19 vaccine” sticker. This suggestion is great, as I wrote also in my article from July, the challenge of intangibility was already very much present in relation to keeping up preventive measures against the epidemic in the first place (hand-washing, wearing masks, …) and this nicely addresses it. Retirement saving faces a similar challenge as the benefit of retirement saving is also for the most part intangible.   

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If we return to Covid-19 vaccines, Nobel laureate Richard Thaler proposes in his The New York Times article selling a small proportion of early doses to the rich and famous. Besides raising money that could be used to help the ones most hit by the epidemic, Thaler believes other people seeing celebrities make large payments for vaccines could be persuaded to follow them and also get vaccinated. One important thing Thaler also stresses is making it easy to get the vaccine. Making the process as smooth as possible and also once people get the first shot immediately scheduling their second shot and get them to make specific plans to come and then send them electronic reminders for their appointments [2]. These kinds of electronic or phone prompts have been well proven to increase anything from credit card repayments to visiting doctors appointments and Nina Mazar, Daniel Mochon and Dan Ariely have written a nice piece about it [3].

Making saving for retirement easy with as little friction as possible has been one of the priorities of many programs designed to promote retirement saving and the program Richard Thaler devised together with Shlomo Benartzi (Save More Tomorrow) emphasised among many things just that. One of the more ingenious ideas in their program was automatic enrolment in workplace retirement saving plans that turns the behavioral bias of procrastination (status quo bias) around to help us save for retirement instead of hindering it. Just an idea, but maybe automatic enrolment with the option of opt-out could also be used in vaccination programs with large employers once the supply of vaccines will be sufficient and that will for sure massively increase the uptake, as the default option would be for all employees to get vaccinated and the ones who will not won’t it will need to opt out.  

The World Health Organization also did not forget about the role behavioral science can have in increasing vaccine uptake and published a special report on behavioural considerations for acceptance and uptake of COVID-19 vaccines prepared by it`s Technical Advisory Group chaired by Cass Sunstein.

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The report explores many factors influencing vaccines uptake, from environmental factors giving vaccination in a close by, convenient locations free of charge, to making social norms in favour of vaccination more salient, supporting health professionals to promote vaccination and amplifying endorsements from trusted community members. The report also establishes it will be key to increasing motivation of people through open and transparent dialogue and communication about uncertainty and risks, including around the safety and benefits of vaccinations [4]. 

With all the behavioral science experts contributing their ideas on how to increase covid-19 vaccinations I have no doubt we will quickly get there, I just really encourage politicians and others influencing public policies to listen to them and use their wast experiences to help end this pandemic as soon as possible and save as many lives as possible. And once it’s over let’s not forget the lessons learned and put our focus on the next big threat to our societies which is the demographic shift and the retirement saving crisis which is also intangible and distant, the same as Covid-19 was in march, and we need to address this issue head on and behavioral science can make all the difference. We just have to use it. 

References:

[1] Kathy Milkman, Katy Milkman on how to nudge people to accept a covid-19 vaccine. The Economist, 2020. Retrieved from: Responding to covid-19 – Katy Milkman on how to nudge people to accept a covid-19 vaccine | By Invitation | The Economist 

[2] Richard H. Thaler, Getting Everyone Vaccinated, With ‘Nudges’ and Charity Auctions, The New York Times, 2020. Retrieved from: Getting Everyone Vaccinated, With ‘Nudges’ and Charity Auctions – The New York Times (nytimes.com)

[3] Nina Mazar, Daniel Mochon and Dan Ariely. If You Are Going to Pay Within the Next 24 Hours, Press 1: Automatic Planning Prompt Reduces Credit Card Delinquency. Journal of Consumer Psychology published by Wiley Periodicals, 2018. Retrieved from: If You Are Going to Pay Within the Next 24 Hours, Press 1: Automatic Planning Prompt Reduces Credit Card Delinquency – Mazar – 2018 – Journal of Consumer Psychology – Wiley Online Library

[4] Behavioural considerations for acceptance and uptake of COVID-19 vaccines: WHO Technical Advisory Group on Behavioural Insights and Sciences for Health, meeting report, October 2020. Retrieved from: 9789240016927-eng.pdf (who.int)

The behavioral side of ESG investing in retirement plans

ESG are the three letters that are nowadays tough to avoid in any conversation about retirement saving. Some even call it the next big thing after target date funds. ESG stands for using Environmental, Social and Governance factors to evaluate potential investments of pension funds. Looking at it from an alternative perspective, not just purely financial, brings to light some interesting new arguments in favor of ESG, that might just bring to retirement saving something that has long been missing. What am I getting at?

One of the main challenges of retirement saving is that you have to pay contributions for 40 years and in this long time period you get nothing in return, except the promise of financial security in retirement, which doesn’t really make most people sleep any better at night. Buying a new car or a house with credit gives you just the opposite, for a monthly installment you get to drive your dream car every day, or you and your family get to enjoy your beautiful new country home, giving you lots of joy and other positive emotional rewards every single day. Retirement saving is intangible and if you are not like me and get excited over looking at your online savings account, doing the right thing and saving for retirement doesn’t really give you much positive emotional rewards while you are doing it and you have to wait a long time for the reward. Even when you finally get it, whether it be a monthly annuity, or some other form of draw down, it is far from something exciting.

Well ESG might just help with that as incorporating ESG principles in the investment strategy of your retirement plan might give you some benefits of retirement saving now, as you will literally help save the environment, get cars of the streets, shut down those pesky coal plants and save the wildlife all in one go (not being cynical at all here). The biggest side effect of ESG investing might be just that –  giving savers some tangible rewards now and with that helping them to overcome intangibility and also the other bias working against retirement saving, which is present bias. It refers to our tendency to give stronger weight to payoffs that are closer to the present. Most of us are impatient and would like immediate gratification if possible and that has a big influence on our daily decision making and for sure does not help retirement saving. We will always rather spend our paycheck on new shoes, purses or other consumer goods that promise us instant satisfaction, than save it for our retirement. That’s just how we are wired and you can read more about the present bias and financial behavior in an article by Jing Jian Xiao and Nilton Porto [1].

Thinking about it I really believe ESG might help with giving pension plan members some instant satisfaction and every month when they will make their contributions to the plan they might just feel some warmth in their hearts about doing something good in this world and it’s all thanks to their retirement plan. And when did you last feel some warmth in your heart when thinking of your retirement plan? Probably never. So ESG has potential to capture people’s hearts and minds, as the saying goes, but as always, the devil is in the details. Key to this will be communication with members and folks at UK`s Nest Insight are already on to this and have ongoing studies focusing on how ESG investing can be used as a motivator of pension engagement. Their latest research programme looked at whether communicating with pension plan members about the positive impact of their investments could make them more likely to engage more with their retirement plan. So what did they find out?

As expected ESG is no silver bullet and their research suggests communications around ESG issues do not engage everyone in the same way and for some the additional information is too much and reduces potential engagement. Still they found out that overall, a responsible investment message had broader appeal than a more traditional investment message. Interestingly “ESG” does not seem to be the term that engages pension plan members very effectively and they suggest the phrase ‘responsible investment’ to work better by conveying prudence and safety and also at the same time communicating a focus on investing more sustainably for the future. Framing the messages related to ESG or responsible investment will be key and they provide some good hints on framing the messages in the right way, for example framing the messages about investments as proactively doing good instead of framing them as avoiding the bad. Their initial findings suggest ESG investments have potential to increase engagement with pension plan members, if done the right way and to reach members who would otherwise not be engaged at all [2]. 

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We also need to keep in mind that the generation of millennials is more and more represented in retirement plans as baby boomers are entering retirement so finding topics to engage millennials in connection with retirement saving will be key for the future and what better topic to connect millennials and retirement saving than ESG. Millennials are already known for preferring to invest in alignment with their personal values. Survey of high net worth investors from Morgan Stanley Institute for Sustainable Investing found that 95% of millennials were interested in sustainable investing [3] and EY`s research suggests millennial investors are nearly twice as likely to invest in companies or funds that target specific social or environmental outcomes [4]. So with millennials soon becoming the most important generation for retirement plans they need to adapt to this and start addressing the issues that matter to millennials, if they will want to win them over, otherwise they may save for retirement somewhere else.  

Clearly the topic of how ESG investing should be communicated to members of pension plans needs to be more researched and foremost tested in real life. Luckily Nest Insight already plans to go further with their research in this field and I really look forward to more of their results that are scheduled to be published in 2021. The new generation of savers will look not only at yields and fees, but will expect something more of their retirement plan and it`s investments – making a positive impact now and the retirement industry needs to adapt to this for the good of all of us.

References: 

[1]. Jing Jian Xiao and Nilton Porto, Present bias and financial behavior, Financial Plannin Review, Volume 2, Issue 2, 2019. Retrieved from https://onlinelibrary.wiley.com/doi/full/10.1002/cfp2.1048  

[2] Jo Phillips and Will Sandbrook, Nest Insight, London, 2020. Retrieved from https://www.nestinsight.org.uk/wp-content/uploads/2020/11/Responsible-investment-as-a-motivator-of-pension-engagement.pdf

[3] Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice. Morgan Stanley Institute for Sustainable Investing, 2019. Retrieved from: https://www.morganstanley.com/pub/content/dam/msdotcom/infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_White_Paper_Final.pdf 

[4] Why sustainable investing matters, EY Americas, 2018. Retrieved from: https://go.ey.com/2DGmfWr

The dangers of anchoring in retirement saving

Ever wondered why many restaurants feature lobster or other expensive dishes at the top of their menus? Well one thing is for sure, it’s not a coincidence and the main function of the lobster is not for you to order it but to make other dishes look less expensive. Let me explain.

Anchoring is one of the more well-known behavioural biases in finance and also many seasoned marketers are well aware of it. Anchoring is a form of priming effect whereby initial exposure to a number serves as a reference point or anchor that influences all our later decisions. If that sounded too complicated here is a short example. If you go to a coffee shop and see first on the menu a $4,65 Cinnamon Dolce Latte this serves as an anchor to which you compare prices of all other beverages and all of a sudden that $3,45 Caffee Latte looks like a real bargain. But what would happen if you would not see the initial high anchor of the Cinnamon Dolce Latte, would you still perceive the $3,45 Caffe Latte as a bargain? Probably not. This is why nowadays many bars and restaurants turn the design of their menus in real science and you can read more about it here. Also providers of other goods and services, from mobile operators to tourist agencies, use anchoring extensively to sell us more. 

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But since I write about retirement saving let’s look at anchoring in finance. Nobel laureate Robert Shiller was one of the first to study anchoring in stock exchange trading and found investors are often anchored on the purchase prices of shares that serve as a psychological benchmark for future investment decisions [1]. The anchor price carries a disproportionately high weight in an investors decision-making process and often leads to bad investment outcomes. For example, if you purchased Tesla shares this august for $300, then this price will serve as an anchor for all future sales or purchases of this stock, regardless of how the stock actually performs and how Tesla is operating in reality. All future trades will always be measured to the $300 anchor. Because of this investors tend to hold investments that have lost value, because they hope they will return to the purchase price and by that they are taking on greater risk and blindly chase the purchase price, sometimes even to zero. 

We judge other financial products in a similar way, and if I had the last deposit at a 3% interest rate, I am very disappointed with the deposit offer today, as I still judge all current offers by how much they are lower or higher than the last offer I got. The fact the interest rates plummeted to zero or even negative doesn’t change my sentiment as the anchor effect still follows me.

Can anchoring also hurt my retirement nest egg? 

Unfortunately in many ways. One thing professor Shiller also found out was that besides the so-called quantitative anchoring, which is related to numerical values, we are also influenced by moral anchors which is the influence of intuition and emotions. A nice example of moral anchoring is investing pension savings in shares of the company where you are employed. This is very common in the US, where even today more than half of employees have most of their retirement savings invested in shares of the company where they work and you don’t need a Nobel prize in economics to figure out this is not wise. Shlomo Benartzi and Richard Thaler wrote back in 2007 about employees investing retirement savings in their employer’s stock as an example of poor diversification [2]. This occurs because we feel, when investing in shares of companies where we work, a false sense of security, as we feel we know the company more than others and because of this, we perceive it as a safer investment. Because of moral anchoring a plant worker employed by Ford, will much rather invest his retirement savings in Ford shares than BMW shares or even a diversified portfolio of shares. By doing this employees take on too much risk, as if something goes wrong with the company where they work, they will not only lose their job, but also their retirement savings.  Not to mention investing in only one share is far far more risky than investing in a diversified portfolio.

Anchoring also has a big effect on contribution rates of retirement plans as employees often anchor on the maximum rate matched by the employer, the maximum rate allowed by the plan, or a round number. So for example, if the employer matches contributions up to 4% of employees salary, most employees will also contribute 4%. I see the same pattern in the corporate pension plans we manage in the pension fund I work in Slovenia (Pokojninska družba A) where we manage more than 200 corporate plans and in the plans with an employer match most employees contribute the same amount. To test if individuals are also influenced by anchoring I conducted an empirical analysis of contribution rates of our individual pension plan a few years ago. The analysis included four years of data (N = 5,678) and revealed members chose monthly contributions that were round numbers and multiples of five far more frequently than would be expected by chance. Two levels of contributions in particular (€50 and €100) stood out. The analysis also revealed the power of anchoring as the plan’s minimum monthly contribution of €26.8, which is stated on the entry form, was also among the most frequent contributions. You can read more details about the analysis and round number bias in my article for the Behavioral Scientist Magazine [3].

15 most frequent monthly contributions to the individual pension plan of Pokojninska družba A in 2015. Members who chose annual contribution were excluded as the focus was on monthly levels only.

Minimum contributions will not be enough

Anchoring on the minimum level of contributions is really dangerous as they will just not suffice to build up a big enough retirement nest egg to provide sufficient income in retirement. One quick fix we did in our pension fund right after my analysis, we eliminated from the entry form the caveat where minimum monthly contributions were stated and we designed a special mobile app and web calculator that enabled potential members to calculate how much they should contribute in order to accumulate sufficient assets. This way we established a connection between the level of contributions members pay, to the amount of income they can expect to receive once retired and this gave them a better indication of how much they should contribute and steered them away from anchoring to the minimum amount. 

Defaults to the rescue

Voya Financial, a provider of retirement products in the US where professor Shlomo Benartzi also works as an academic advisor for their Behavioral Finance Institute, experimented with pushing up default contribution rates in their retirement plans and found out pushing default contribution rates on the high side is less likely to generate unintended consequences than erring on the low side. This means, it absolutely makes sense for default rates of corporate plans to be as high as possible and go even into double digits, as they do not scare off employees from saving. More details on how defaults can be used to increase retirement saving in a working paper by Beshears, John et al [4]. 

One also very effective way of getting members off their default contribution rates is automatic escalation of contributions which is quite an old idea, but one still not explored enough. This way contributions rise automatically every year and even if I start with a low level they will be, effortlessly and without any decisions and cognitive effort from me, increase over time to an appropriate level. When mandatory automatic enrollment in corporate retirement plans was introduced in the UK a few years ago it featured a smart policy of automatically increasing contribution rates over time and it worked marvelously as research from NEST Insight shows the increases had no material impact on members and the proportion of members ceasing payments because of it was minimal. 

Defaults can also help against moral anchoring on company stocks mentioned before and retirement plans should have diversified life cycle funds as the default investment choice and this way most members would be saved from investing in risky company stocks. The same can be used in the future to promote ESG investing that could be made the default option in corporate pension plans.

As we see, we can quite quickly and without even noticing it anchor ourselves into bad choices and they can in the end cost us much more than juts paying for that over priced Cinnamon Dolce Latte. Hopefully the retirement industry will be, with the rise of smart decision tools like retirement calculators, advanced online accounts incorporating robo-advisors and personalised recommendations, able to harness anchoring for positive reasons to help people save more for retirement and keep their savings invested in the right way. Until then, we need to be aware of its presence and not be tricked into ordering too many lobsters or overpriced coffee along the way. 

References:

[1] Shiller, R. J.. Irrational exuberance. Princeton, NJ: Princeton University Press, 2015.

[2] Benartzi, Shlomo & Thaler, Richard. Heuristics and Biases in Retirement Savings Behavior. Journal of Economic Perspectives, 21 (3): 81-104, 2007. Retrieved from: https://www.researchgate.net/publication/4981794_Heuristics_and_Biases_in_Retirement_Savings_Behavior 

[3] Vižintin, Žiga. Why Five and Not Eight? How Round Number Bias Can Reduce Your Nest Egg. The Behavioral Scientist. Retrieved from:  https://behavioralscientist.org/five-not-eight-round-number-bias-can-reduce-nest-egg/ 

[4] Beshears, John and Benartzi, Shlomo and Mason, Richard and Milkman, Katherine L.. How Do Consumers Respond When Default Options Push the Envelope? 2017. Retrieved from : https://professionals.voya.com/stellent/public/6114876.pdf

(Over)optimistic Millennials and Gen Z wishing an early retirement

According to the latest Vanguard Digital Advisor survey, Millennials and members of the Gen Z generation are planning an early retirement as most of Gen Z (67%) and Millennials (61%) plan to retire before the age 65. Some are even more optimistic, as nearly a third of Gen Z (31%) and nearly a quarter of Millennials (22%) plan to retire before 60. Just to clarify, the survey counts as members of Gen Z people born from 1997 to 2002 and as Millennials all born from 1981 to 1996. More results from the Vanguard survey below [1].

So what’s going on and why would Millennials and Gen Z think they will be able to retire early, as on the other side the legal retirement age, at which employees can start receiving public pension, is increasing all over the globe. In the US the full benefit age is currently 66 years and 2 months for people born in 1955, and it will gradually rise to 67 for those born in 1960 or later. In the UK the state pension age is currently 65 and will gradually increase to 67 by 2028.

Optimism bias

Optimism bias can partly explain the survey results as behavioral and neuroscientists established humans have a natural tendency to overestimate the probability of positive future events and underestimate the probability of negative ones. Here the positive outcome is obviously being able to retire early. 

Nobel Prize-winning economist Angus Deaton explains that one possibility is, that overoptimism is biologically built into human beings as we need to believe that the future is going to be better than today, or else we wouldn’t be as motivated to survive and that optimism bias may be part of the normal healthy brain. Deaton analysed in his National Bureau of Economic Research paper data of 1.7 million individuals across 166 countries from 2006 to 2016 for the Gallup World Poll and found people to be weirdly hopeful about their future [2]. 

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One of the leading neuroscientists researching optimism bias is Tali Sharot. She describes it as a cognitive illusion that developed during our evolution as the answer to another unique human ability of conscious foresight (mental time travel). This ability enables us to think about ourselves in the future and by doing this we can, among other things, also imagine our own death or other bad things. The reasoning goes, optimism bias developed as an answer to this, as without developing positive biases during evolution, we could not function normally every day knowing death is around the corner [3]. For more info on optimism bias you can check out a great TED talk from Tali, where she also shares some fun experiments exposing our over-optimistic outlooks. 

Older workers too optimistic about their ability to work

If young workers are too optimistic about when they will be able to retire, the older workers are influenced by optimism bias in a different way, as most of them overestimate their ability to work.  

The Health and Retirement Study from the Center for Retirement Research at Boston College reveals roughly 37% of those working at age 58, in the end, retired earlier than they were planning [4]. Prudential’s latest study also reveals the similar gap in optimistic outlooks and reality as 51% of retirees in reality retired earlier than planned. Only 23% retired earlier than planned voluntarily, meaning they had enough money saved or were just tired of working. The majority of those who retired earlier than expected did so involuntarily. 46% because of health problems, 30% were laid off or offered an early retirement package, and 11% left work to take care for a loved one.

Retiring early has a big negative impact on income in retirement, because of lower social security and also lower private savings due to a shorter saving period. The last few years before retirement are important to building our retirement nest egg as they are on average also our top-earning years and losing just one year can influence our quality of life for the whole retirement.

High cost of overoptimism

So our overly optimistic outlook of the future can have dire financial consequences for our retirement and we need to acknowledge this and factor it in our prediction on when we will be able to retire, or on the other side how long we will be able to work. Let’s keep in mind life is not always just about the optimistic scenario and the current pandemic can serve as a grim reminder of this and let’s make calculations also for the pessimistic scenario. This way, we will be good either way.   

References:

[1] A Vanguard Digital Advisor survey. The Vanguard Group, 2020.

[2] Deaton, Angus. What do Self-Reports of Wellbeing Say about Life-Cycle Theory and Policy? NBER Working Paper No. 24369, 2018. 

[3] Sharot, Tali. The optimism Bias – A Tour of the Irrationally Positive Brain. New York, NY, US: Pantheon/Random House, 2012.

[4] Munnell, Alicia H., Sanzenbacher, Geoffrey T. & Rutledge, Matthew S. What causes workers to retire before they plan? Center for Retirement Research at Boston College, 2015.  

Behavioral lessons for the second pension pillar in Slovenia

Existing from 2001, the second pension pillar in Slovenia is represented by private defined contribution retirement plans managed by specialised pension funds and insurance companies. The number of members has been steadily growing and at the end of last year reached 560.722 members, which is the highest number ever. This means the coverage rate is roughly 62 % of all persons in employment, which is a fairly decent rate for a voluntary system. But if we take away members of the civil servants mandatory retirement plan (approx. 235.000) the coverage rate drops to a more sobering 36 %. 

One interesting statistics exposes nicely the power of behavioral biases working against individuals to start saving for retirement, as the vast majority of the second pension pillar members in Slovenia (97%), are enrolled in corporate pension plans financed by their employers and only 3% of members save individually, despite the government’s tax incentives. 

This percentage has been the same for 19 years proving jet agin, tax incentives for retirement saving have a very limited effect and only a very small percentage of employees decide on their own (not by their employer) to start saving for retirement. You can read more on why tax incentives for retirement saving don`t work in my previous blog post

Total assets of pension funds also recorded steady growth and reached 2,62 billion Euros, representing a 12% growth from 2018. Despite the relatively large growth, assets of pension funds as a percentage of GDP remain at around 5% which is low compared to some other emerging Europe countries, as is evident from the chart below based on OECD statistics. The main factor influencing the growth of private retirement assets was the original design of the system and how members were enrolled. In countries like Croatia, Kosovo and Estonia, large assets are mainly thanks to mandatory enrolment in private retirement plans.

After 19 years we can say the second pension pillar in Slovenia reached average coverage rates for a voluntary retirement system and even that is mainly thanks to employer sponsored corporate plans. Tax incentives proved, as in many similar cases, ineffective to generate individual retirement savings. The main challenges for the future remain, how to increase enrolment and contribution rates in order to provide adequate income in retirement for the majority of future retirees, which will be more and more dependent on private pensions.

Where to go next?

Automatic enrollment in retirement plans is a great example of behavioral economics in action, where workers are defaulted into saving, but can always opt out. The United Kingdom is a great example of a successful implementation and employees were automatically enrolled in retirement plans from 2012 onward (first big companies, then medium and down to small), and to date it has helped over 10 million people to start additionally saving for retirement. After 8 years the coverage rate of retirement plans increased from 60 % to 90 % making it a great success. They did not stop at just auto-enrolment, but also contributions of members are auto escalated over the years making sure members will have sufficient assets at retirement. You can find more info on UK`s auto enrolment and the behavioral science behind it in the recent report from Nest Insight.  

Ireland is following and plans to implement by 2022 a defined contribution auto enrolment system of supplementary pension savings for all employees between the ages of 23 and 60 who earn €20,000 or more. Auto enrolment will be phased-in and minimum mandatory contributions will be set at 1.5% of gross earnings and then increasing by 1.5% every three years until year 10, when they will reach 6%. The detailed legislation is still being drafted but you can find some more information on the plans in the report by Mercer

Some US states, like California, Oregon and Illinois, are also following the lead with implementations of state-sponsored retirement savings plans in which employees are automatically enrolled. Oregon’s plan OregonSaves began in 2017, Illinois in 2018 and California started its CalSavers at the end of 2018. What is even better, more and more states are following their lead and the existing plans proved very resilient even to the latest COVID-19 crisis.

Auto enrolment in retirement plans and then auto escalation of contributions proved as a wining combination and I see no reason, why we should not learn from their experiences also in Slovenia and implement the proven lessons from behavioral economics to our retirement plans to increase coverage and assets and by that securing a brighter future for our citizens. With more and more strain on the public first pillar, additional revenue from private retirement plans will in the future not be any more a luxury, but a necessity.      

Saving for retirement with your credit card (Overcoming loss aversion and temporal discounting)

Why would anybody in their right mind pay pension fund contributions in installments with his or her credit card is the question most would ask after reading the title, but if you give me a bit of “credit” I will try to explain the logic. 

Retirement saving is unfortunately plagued with behavioral biases that negatively affect various stages of retirement saving, from why we don’t start saving, to where we invest and how we draw down our savings. Renowned behavioral economists like Shlomo Benartzi, Richard Thaler and Brigitte Madrian, just to name a few, identified many biases in retirement saving more than a decade ago and among the more prevalent are also loss aversion and temporal discounting. 

Loss aversion was described nicely by Kahneman & Tversky with “losses loom larger than gains”, meaning the pain of losing is psychologically more powerful as the pleasure of gaining an equal amount so “it is better to not lose $5 than to find $5”. That is why, when we are faced with paying contributions in a pension fund, we only feel the pain of paying. To make it even worse, we get nothing back in return as the “reward” of retirement saving comes only decades later, when we retire. 

Now we come to the second bias which is temporal discounting. Research shows we value more present rewards than future ones. If the reward is very distant in the future our perceived value of it goes towards zero. If we promise someone to save for 40 years and after that you will have a $400.000 pension pot, the 40 years of temporal distance reduces the psychological value of the savings close to zero. 

So what can we do about it?

In the pension fund I work in (Pokojninska družba A, Inc.), we experimented with a surprising solution that comes in a form of a Diners Club credit card that enables payment of various goods in up to 12 installments. Most people use Diners Club cards, or any other credit cards, to purchase in installments a new sofa or a new ultra HD television, but we decided to use instalments in another way. As in most countries, the government in Slovenia also incentivizes private retirement savings with special tax incentives. If you save on your own the contributions reduce your income tax base and you get part of the contributions back the next year. For example, if you pay annually €2.000 and are in the highest tax bracket, you get refunded €1.000. Not bad, right. The catch is, you have to pay contributions until the end of December in order to lower your income tax for the current year. 

The challenge

Many people don`t pay contributions regularly during the year and would then like to pay all of them in December, which is also a month that is “heavy” on the wallet with expenses for Christmas and New Year`s. Every year I had many talks with clients, who would like to pay their annual contributions, but were running low on cash because of gifts and in the end they missed the payment and by January all was forgotten. The story repeated every year and one day, when I was thinking how we could fix this, it came to me. Why not pay pension fund contributions in several instalments with your credit card in the same way you use it to pay for a new sofa? This way you could still get the tax incentive and lower your income tax, even though you would actually pay contributions in the next year. To test if the theory could be put in practice I called up the Slovene franchise of Diners Club and after their initial surprise we came to the conclusion, that it could work. 

We decided to go for online payments only via our website where anybody can fill in a special web form to first become a member of our individual retirement plan and at the end they have a choice to select online payment of contributions with Diners Club credit card. Once selected they input the annual contribution amount and select the number of installments (limited to 12). Then they are redirected to the payment gateway where they finish the transaction in the same way as buying a new book on Amazon. The whole process takes minutes and the next working day we receive the payment of the whole annual contribution from Diners Club which goes immediately on the individual saving account and also reduces the income tax base of the member. The cost of the payment in instalments is also low and transparent at €1 per installment. 

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It works

This new payment option addresses the behavioral biases of loss aversion and temporal discounting mentioned before, as it allows people to receive the full tax incentive on the payment and by that giving them some gratification now. Secondly, the pain of paying contributions is pushed into the future and the same temporal discounting is now working for us positively to reduce the pain we feel when making pension fund contributions. There is an added positive effect of instalments which split the annual contribution into smaller amounts thus reducing the pain of paying even more. The whole service is fully digital and someone can complete the whole process with a few clicks, thus simplifying and removing behavioral burdens of retirement saving. We launched the program at the end of 2016 and so far it’s been a great story. In majority, we found people who used this option did not save before for retirement which proves it solved a real practical problem. At the end of last year more than 10 % of all annual individual contributions to our fund were made with credit cards. Increased contributions mean people will have a better retirement because of it and that’s what it’s all about.  

Further Reading & References:

  1. Thaler, Richard & Benartzi, Shlomo. (2007). Heuristics and Biases in Retirement Savings Behavior. Journal of Economic Perspectives. 21. 81-104. 10.1257/jep.21.3.81. https://www.researchgate.net/publication/4981794_Heuristics_and_Biases_in_Retirement_Savings_Behavior
  1. Brigitte Madrian (2018), LESSONS FROM BEHAVIORAL ECONOMICS FOR PROMOTING RETIREMENT INCOME SECURITY, Retirement Research Consortium Annual Conference, Washington DC, August, 2018 http://www.nber.org/2018rrc/slides1/2.5%20-%20Lunch%20Speaker%20-%20Madrian.pdf
  1. Kahneman, Daniel & Tversky, Amos. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263-291. doi:10.2307/1914185
  1. Bickel, W., Odum, A., & Madden, G. (1999). Impulsivity and cigarette smoking: Delay discounting in current, never, and ex-smokers. Psychopharmacology, 146(4),447-454.

Tax incentives for retirement saving don`t work (what does?)

Most countries, if not all, encourage saving for retirement by taxing retirement savings in private pension plans more favourably than savings in alternative vehicles. The goal is to increase how many people save for retirement and how much they save and with that enable them a better life in retirement. 

Most countries apply a variant of the “Exempt-Exempt-Taxed” (“EET”) regime to retirement savings, where both contributions and returns on investment are exempted from taxation while benefits are treated as taxable income upon withdrawal. There are also other regimes (EEE, TTE, …), but I won’t bore you with them. The main question remains, do tax incentives actually increase retirement savings and at what cost?

Do they work? Not really.

There is a growing body of literature confirming the effect of tax incentives on retirement savings is very limited and also very expensive. According to John Friedman, retirement saving incentives in the US reduced in 2016 the government revenue by $180 billion, which is just over 5 percent of the total federal tax revenue. He finds tax subsidies for retirement saving have a limited effect on how much households actually save and that an increase in savings is in most cases attributed to shifting assets from taxable accounts to retirement accounts, which does not increase the total savings rates, as incentives largely benefit wealthy households who would save anyway. 

A very vivid example of how tax incentives have a limited effect on retirement saving is my home country of Slovenia, whereas in most countries, the government incentivizes private retirement saving. If you save on your own the contributions reduce your income tax base and you get part of the contributions back the next year. For example, if you invest in a pension fund annually €2.000 and are in the highest tax bracket, you get refunded €1.000. Not bad, right and for sure lots of people take advantage of this fantastic tax incentive. Not really, as approximately only 2% of all employees in Slovenia have individual retirement plan. For sure the tax incentive is not the only one to blame for this low number, but it also clearly demonstrates that in the last 19 years, that the tax incentive exists, it convinced almost no one and the percentage of savers did not change over time. You can read more on private pension plans in Slovenia in my LinkedIN article.   

The same findings are confirmed by a large sample study from Denmark that finds tax incentives for retirement accounts, which rely upon individuals to take an action to raise savings, mainly induce individuals to shift assets from taxable to retirement accounts. They estimated that fewer than 20 percent of people respond to changes to tax incentives and that each $1 of government expenditure on incentives increases total saving by only 1 cent. On the other side they find policies that raise retirement contributions if individuals take no action – such as automatic employer contributions to retirement accounts – increase savings rates substantially. Automatic contribution policies also have lower fiscal costs, generate relatively little crowd-out, and have the largest impacts on individuals who are paying the least attention to saving for retirement.

What works?

Automatic enrolment in retirement saving is a great example of behavioral economics in action, where workers are defaulted into saving, but can always opt out. The United Kingdom is a great example of a successful implementation of automatic enrolment in retirement plans which was phased in from 2012, and now after 8 years it is still going strong with opt-out rates of only 9 percent. To date it has helped over 10 million people to start saving for retirement making it a great success. 

Some US states are also following the lead with implementations of state-sponsored retirement savings plans in which employees are automatically enrolled. Oregon’s plan called OregonSaves began in 2017, Illinois began its programme in 2018 and California started its  CalSavers programme at the end of 2018. Even better, more and more states are following their lead. Results so far from all the state plans are very encouraging and many new employees are now covered by retirement plans making a huge impact on their future life quality, showing jet again it’s not about tax incentives, but about designing smart retirement plans incorporating the latest findings from behavioral economics and with the help of modern information technology sky is the limit.   

COVID-19 lessons for retirement saving

The reasons why most people, from the average Joe, to experts and politicians, initially did not take the coronavirus COVID-19 seriously are largely the same, as the reasons why most still do not take climate change seriously, exercise regularly or save for retirement. We can look for the culprits in an intertwined web of behavioral biases that affect our behavior, from the most trivial things, like why we buy that overpriced cinnamon dolce latte at Starbucks, to the most serious, as is the pandemic we are just living in.

Let’s be honest, no one imagined back in February that we would ever experience the closure of schools and kindergartens, that all bars and restaurants would be shut down, and we would not be able to hang out with friends or relatives even in our homes. Even the most pessimistic of us did not imagine the eerie scenes of empty streets and city squares, since the threat of the coronavirus COVID-19 was far away in a Chinese city of Wuhan, which most of us had never even heard of before. This great distance in a way calmed us down and gave us psychological comfort, as we all privately thought – this is far away, with all the preventive measures the virus will for sure never reach us. We will not go on vacation to Asia for a while and everything will be OK. Then, we pushed our worries into the subconscious and went back to our daily routine. Soon it all came crashing down and on March 4, the first case of coronavirus infection was confirmed in Slovenia, my home country, and on March 16 life as we know it was shut down. Even those of us who are more optimistic began to worry, when empty shelves were waiting for us at the supermarket.

Intangible threats

Why did we not worry about the first cases of coronavirus in China, and why did we suddenly run to the shops and start accumulating toilet paper, when the virus came to our countries? The threat of the coronavirus, or any other virus, is completely intangible to us and it also does not help, if the epidemic is happening on the other side of the world. An old proverb nicely puts it, out of sight, out of mind.

The coronavirus threat was hard to imagine and we could not grasp it, both physically and mentally. Unlike some other natural disasters, for example an earthquake in a neighbouring city. We see footage of damaged buildings, many also have acquaintances or relatives there and immediately we have a stronger emotional reaction to such a natural disaster. In our minds, we can quickly picture our own house being damaged by an earthquake and questions like, what would happen to my house, would my family survive, start stirring our imagination and fears.

Gretchen Chapman and George Loewenstein, both professors at Carnegie Mellon University, point out in their recent article the challenges of intangibility in relation to keeping up preventive measures against the epidemic, such as maintaining physical distance and hand-washing “as you can’t touch, taste, feel or see the benefits of, for example, wiping off your door knob”. They also point out, the benefits of preventive measures seem intangible, because people don’t get useful feedback about the effects of their actions, as the microbes are invisible and we have no idea if we have gotten rid of them by washing our hands or disinfecting our grocery. We also get no feedback about how protective actions have changed our probability of getting infected. Even worse, If our actions work, the outcome is we don’t get sick, but that is already the state in which we were in before we took the measures. This way it seems, the preventive actions cause nothing to happen as we can’t imagine the negative outcome that might happen, if we did not exercise preventive actions in the first place [1].

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On the other side, Kristen Berman highlights how people react strongly to visual threats such as wildfires in San Francisco, where most residents immediately put on protective masks when they see smoke in the air, even though there are other threats besides low air quality, that threaten their long term health much more, or as she puts it “Based on the reaction of Bay Area residents to smoke-filled air, compared to all other risks they face, an alien may logically conclude air quality is a threat we should prioritize above all others” [2]. Unfortunately, the coronavirus is not accompanied by smoke or other visual cues, which makes it more difficult to imagine and the threat is therefore much easily underestimated. The same goes for retirement saving, as workers get no visual or any other warnings, that they have insufficient retirement savings. Also the ones who are saving get in most cases no tangible feedback about their savings and how they will improve their future life quality once retired.

Intangible and distant

In addition to intangibility, our response to the coronavirus was also diminished by myopia or short-sightedness, which is our tendency to focus only on the current state. Myopia is well known in finance as it together with loss aversion makes investors view their investments only short-term. This means that in market down-turns, like we have just experienced, most investors react too strongly to losses and forget about the long-term potential of their investments [3]. This is known as myopic loss aversion.      

Thus, despite the warnings at the beginning of February, we could not imagine the coronavirus would really spread to our countries, since at that time everyone was focused on their current affairs. We face similar challenges with regards to keeping up preventive measures against the spread of the coronavirus, as unlike wearing face masks in the case of forest fires, where the face mask offers immediate relief, as we breath less ashes and other harmful substances [2], we get none of that immediate relief in the case of wearing a face mask in a coronavirus epidemic. Remember the first weeks of the epidemic, when we all adhered to the preventive measures, the number of infected still increased daily and we did not receive any positive feedback. This made it all the more difficult to keep up with the measures and this will present an even bigger challenge for the future, when the epidemic will calm down, but protective measures will still be needed. 

It is similar to eating healthy or exercising regularly, we will not feel any better tomorrow, but the positive effects on our health will come only after years. Similar is with saving for retirement, where we set aside a certain amount of money on a monthly basis, only to receive an additional pension after 30 or 40 years. It is completely different when buying a new car or a house, where in exchange for a monthly instalment of credit, we can drive our dream car out of the salon today. Therefore, it is not necessary to say twice, the majority chooses to buy a new car, instead of saving for retirement.

Optimism bias

Going back to the coronavirus and our ignorance of the possibility of it spreading to our home countries, optimism bias also played a role. It is considered to be one of the most prevalent and robust cognitive biases as research found people of all nationality, age, gender and race, attribute to future positive events a much greater likelihood of realization than negative ones [4]. For the most part, we ignore historical evidence and statistics, because a car accident or Alzheimer’s will for sure never happen to us and public pensions will be enough for a decent living in retirement.

One of the world’s leading neuroscientists, Tali Sharot, interprets optimism bias as a cognitive illusion that humans live with, though without realising its impact on our behaviour. Since humans possess, as one of the few species, a unique ability of conscious foresight (mental time travel), this also means we are aware that somewhere in the future bad things, like death and illnesses, await us. Without developing positive biases during our evolution, we could not function normally [5]. Biologist Ajit Varki points out that without excessive optimism, humans’ greatest evolutionary advantage – our self-awareness, would become our biggest obstacle and ground us to a halt [6].

However positive for us, our overly optimistic outlook of the future hinders our ability to realistically assess future threats, like the coronavirus, or running out of money in retirement, or not being able to afford needed healthcare. Optimism bias is also dangerous in the current stages of the epidemic, as we interpret positive signs too quickly and forget the epidemic may return in the second wave. That is why, when assessing threats, we must be as realistic as possible and rely on numbers and not emotions. If you would like to read more about the threats of optimism bias on your retirement nest egg, and how to avoid them, you can read my article for The Decision Lab.

Coronavirus COVID-19 lessons

If humanity can learn something from the last pandemic, it is that even though certain threats are intangible and distant, that does not mean they are not real, That goes the same for viruses and retirement saving. And even though the consequences of some of our actions will only be visible in the long run, that does not mean we do not make urgently needed changes in our behaviour today and that goes for individuals and societies. As we have witnessed these days, the consequences of procrastination are unfortunately measured in human lives and we have crucial years ahead of us, where we can still do something more in the light of the inevitable climate and demographic crisis, for which we have today more than enough evidence, to make changes.

References:     

[1] Chapman, Gretchen & Loewenstein George. Hand-washing and distancing don’t have tangible benefits. The Conversation, 2020. Retrieved from: https://theconversation.com/hand-washing-and-distancing-dont-have-tangible-benefits-so-keeping-up-these-protective-behaviors-for-months-will-be-tricky-136457

[2] Berman, Kristen. Wildfires — the perfect behavioral problem. Medium, 2020. Retrieved from: https://medium.com/@bermster/wildfires-the-perfect-behavioral-problem-3c25c6209e2f

[3] Thaler, R. H., Tversky, A., Kahneman, D., & Schwartz, A.. The effect of myopia and loss aversion on risk taking: An experimental test. The Quarterly Journal of Economics, 112(2), 647-661. 1997.

[4] O`Sullivan, P. Owen. The neural basis of always looking on the bright side (Dialogues in philosophy, mental and neuro sciences), 2015.

[5] Sharot, Tali. The optimism Bias – A Tour of the Irrationally Positive Brain. New York, NY, US: Pantheon/Random House, 2012.

[6] Varki, Ajit. Human Uniqueness and the denial of death. Nature 460, No. 7256, 2009.