Since traditional pension plans have gone the way of the dinosaur, employees have been forced to take responsibility for ensuring they have enough money saved on their own to last through retirement. But many of them are making inadequate saving decisions and finding themselves facing financial difficulty in retirement. As a consequence, the federal government is reviewing retirement plan rules to determine if the retirement security of participants might be enhanced with provisions aimed at providing a lifetime stream of income after retirement through the use of annuities. Earlier this year, two agencies put out a request for comments on the topic from the retirement plan industry and the general public.
Allianz Global Investors, with the help of Shlomo Benartzi, a behavioral finance professor at the UCLA, reached out to academics in behavioral science, seeking a “key insight” that they believed would be most helpful in crafting policies and solutions with respect to this issue. In its recent response, Allianz presented the insights of the academics and compiled their findings into a checklist to be used by policymakers.
“These insights can add a human dimension to the design of a retirement system, helping to prevent ‘behavioral blind spots’ that could dramatically compromise it,” Prof. Benartzi wrote in the report. “At a time when individuals are asked to assume more responsibility for their retirement savings, we believe the human element is a critical determinative factor.”
Here’s a quick look at some of what I found particularly interesting. Be sure to check out the response in full and let me know in the comments below which ideas you find most interesting and why.
Addressing Retirees’ Sensitivity to Loss
Researchers have shown that investors experience the pain of financial loss far more than the pleasure of comparable financial gain. Eric Johnson, a professor of marketing at Columbia Business School, has found that for retirees, the stronger reaction to loss is even more acute. But he has also found that retirees respond less favorably to financial products with more protection and guarantees. His explanation for this apparent contradiction is that retirees actually view giving up control of their money — and giving up the ability to withdraw money when they want it — as another type of loss. This research suggests that products with guarantees and protection should be positioned as a way for retirees to gain control of their finances and spending and policymakers should consider if a proposed solution is appropriate for retirees who are very sensitive to losses.
Tangible Mental Accounts
Researchers have also shown that people tend to divide their money into separate mental accounts for various purposes (think travel or dining out) and that earmarking savings to specific goals (college savings, for instance) tends to increase saving rates. George Loewenstein, a professor of economics and psychology at Carnegie Mellon University, has proposed applying these concepts to retirement. The idea would be that retirees have separate accounts for various purposes and use different investment strategies with different levels of risk for each. For policy makers, the idea would be to ask whether the retirement income strategy offers “multiple accounts to facilitate different goals, such as paying the rent or spending money on vacations.”
Positioning Products as Income Solutions
A variety of studies have established that how an issue is framed can have a dramatic impact upon whether and to what extent is it accepted. Prof. Jeffrey Brown of the University of Illinois notes that “the context in which retirement income solutions are presented has a dramatic effect on their attractiveness.” In his view, retirement income solutions need to be distinguished from investment alternatives. Accordingly, such concepts should be framed as guaranteed income rather than as anything like an investment return. Indeed, in a study conducted by Prof. Brown, the popularity of lifetime income tripled when monthly spending was emphasized.
Other subjects noted in the report include retirees gravitating to products that are easiest to understand, the typical underestimation of the impact of inflation upon a retiree’s cost of living, and the perceived fairness of a retirement income solution impacting its acceptance. I recommend the report highly and invite your comments below.