How using age-based defaults can nudge 99% of employees to select the optimal retirement plan
Although the impact of default options have been widely studied, the research to date has only examined situations where decisions could still be altered after selection. This intervention examined the effect of age-based defaults on one-time irrevocable decisions about pension plans. They also investigated how individual levels of risk aversion affect personalized defaults. To do this, the researchers examined data from a firm that transitioned from a defined benefit (DB) plan to a defined contribution (DC) plan. Age-based defaults were found to steer 99% of employees to the plan that’s most optimal for them. Additionally, they found that having an age-based default policy is beneficial for a wide range of risk aversion levels.1
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Rating: 3/5 (presentation of results and methods are unclear; the sample may not be representative of the general population)
Default retirement plans tailored to employees’ age can increase retirements savings
|Effect of having the Defined Contribution plan as the default option||70% of employees who made an active choice selected the default. Employees under the age of 45 were 60% more likely to select the DC plan than employees over the age 45.|
|Analysis to find if an employee’s level of risk aversion affected the benefits of an age-based default||Across risk aversion preferences, age-based defaults were more beneficial than a uniform default policy.|
Default: a pre-selected option that is applied if a person does not actively make a choice.
Risk aversion: the tendency to prefer smaller, low-risk gains over larger, high-risk gains.
Defined benefit plan: a retirement plan where the amount an employee receives during retirement is determined by the employee’s earnings and tenure. The employer bears the investment risk and administration costs, and the employee can depend on receiving a predetermined amount of retirement income.
Defined contribution plan: a retirement plan in which the employee and/or the employer contribute to the employee’s retirement. The employee decides how to invest the contributions, thus taking on the risks and rewards of the investment. The total retirement savings depend on the employee's contributions, the employer's contributions, how long the funds have been invested, and how well the investments perform.
Personal characteristics can lead to different retirement incomes
In recent years, legislative changes and rising administrative costs of offering DB plans have resulted in employers shifting towards DC plans. As the DB and DC plans differ in their accrual patterns and risk levels, they may only benefit individuals with specific personal characteristics. For example, less risk-averse young workers would benefit more from a DC plan, as they can accrue more wealth through risky investments with higher returns. Unfortunately, the shift towards DC plans leaves some older employees with non-optimal plans, as the decision about what plan to choose cannot be revoked, leaving some employees with significantly less retirement income. Thus, default options should be personalized and implemented carefully.
Data from a firm switching retirement plans
The intervention used data from a non-profit firm that offered 925 existing employees a one-time, irrevocable choice to switch from a DB plan to a DC plan. If employees did not make a decision, they defaulted into a plan that was optimal for their age group: employees 45 years or below defaulted into the DC plan, individuals 45 and over defaulted into the DB plan. Employees under 45 were considered the treatment group, as they were defaulted into the DC plan. On the other hand, employees over 45 were considered the control group. The researchers compared the number of employees who enrolled into the DC plan when it was the default option and when it had to be explicitly chosen.
Solving for the optimal age cutoff
Since the two contribution plans entail different levels of risk, the intervention also tested whether employees’ risk aversion preferences effected which plan was more optimal for them. Accounting for risk aversion, they reestimated the potential gains of an optimal, age-based default would be relative to a uniform default policy.
The MINDSPACE Framework outlines nine forces that can shape human behavior: Messenger, Incentives, Norms, Defaults, Salience, Priming, Affect, Commitments and Ego. The framework recommends that these forces be considered when creating policies in order ensure optimal results. This intervention utilized the behavioral effects associated with defaults in order to improve employee’s’ long- term welfare by setting a default policy that would result in the largest retirement wealth.
Results and Application
Effects of the default on plan enrollment
The default option had a strong effect on the choices made by employees, as 70% of employees who made an active choice selected the default. Young employees (under the age of 45) were 60% more likely to choose the DC plan than older employees (over 45). Conditioning the default for pension plans based on age was found to significantly improve outcomes compared to a uniform default policy, as an age-based default nudged over 99% of employees towards the plan that was most optimal for them.
Risk-aversion and benefits from default policies
The overall level of risk aversion was found to affect the optimal age cut-off. For younger employees who are not very risk-averse, retirement income is higher in the DC plan. For employees of all ages who are highly risk-averse, the DB plan is superior. They also found that employees who are highly risk-averse are more likely to opt for the DB plan. Overall they found that, for varying levels of risk aversion, age-based defaults significantly increased aggregate wealth relative to the standard method of defaulting all employees to remain in the DB plan.
|Financial Services||Loan or investment sites can set default options based on the user's personal risk preferences or customer segment to provide the best deal to each person.|
|Insurance||Choosing the right insurance plan can be challenging. Personalized defaults could be used to ensure that enrollees get the most optimal health insurance plan for their specific needs.2|
|Retail & Consumer||Defaults on product settings can be set to be the most suitable and safe for the customer’s personal needs. For example, car seats that are generally bought for newborns have a default seatbelt setting that is safest for infants.3|
- It highlights the importance of appropriately setting defaults.
- The study provides novel insights by quantifying the effect of a default on plan choice. Specifically, it provides novel insights about how defaults effect the choice between DB and DC plans.
- The intervention does not explain how levels of risk aversion could be measured and accounted for when setting defaults.
|Does the intervention demonstrably improve the lives of those affected by it?||
|Maximizing retirement savings is likely to improve employee welfare.|
|Does the intervention respect the privacy (including the privacy of identity) of those it affects?||
|The firm and employees were not identified.|
|Does the intervention have a plan to monitor the safety, effectiveness, and validity of the intervention?||
Room for Improvement
|There is no mention of a plan to monitor the safety, effectiveness, and validity of the intervention.|
|Does the intervention abide by a reasonable degree of consent?||
Insufficient Information/Not Applicable
|It is not mentioned whether employees were asked for consent before the data was used.|
|Does the intervention respect the ability of those it affects to make their own decisions?||
|None of the behavioral changes come through force or restriction of options.|
|Does the intervention increase the number of choices available to those it affects?||
Insufficient Information/Not Applicable
|Choices available to the employees remained the same.|
|Does the intervention acknowledge the perspectives, interests, and preferences of everyone it affects, including traditionally marginalized groups?||
Room for Improvement
|The intervention takes into account personal characteristics such as age and risk aversion. However, only one-fifth of the sample was female.|
|Are the participants diverse?||
Insufficient Information/Not Applicable
|The sample was composed of only unionized employees, who may differ from non-unionized employees.|
|Does the intervention help ensure a just, equitable distribution of welfare?||
|The intervention ensures that default policies are set in a way that maximizes wealth for employees.|
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- Goda, G. S., & Manchester, C. F. (2010). Incorporating employee heterogeneity into default rules for retirement plan selection. https://doi.org/10.3386/w16099
- Smart default policy helps lower-income enrollees avoid inferior health plans. (2021, July 22). Contemporary OB/GYN. https://www.contemporaryobgyn.net/view/smart-default-policy-helps-lower-income-enrollees-avoid-inferior-health-plans
- Goldstein, D., Johnson, E., Herrmann, A., & Heitmann, M. (2008, December 1). Nudge your customers toward better choices. Harvard Business Review. https://hbr.org/2008/12/nudge-your-customers-toward-better-choice