Sunday, May 23, 2010

Decision Decisions

As a parent, you spend a lot of time telling your kids what to do, and perhaps more time than you think you should convincing them that it was their idea. If you’re lucky, you get to watch them make the “right” choices on their own—and to see them turn out well in the end. What you really try to avoid doing, certainly as they enter adulthood, is to make those decisions for them.

With defined contribution plans, over the last three decades or so, mostly we told workers what to do (or at least what people very much like them should do). And, despite a lot of hand-wringing to the contrary, most did. There were, of course, “holdouts”—a stubborn and/or inattentive group that resisted those entreaties, at least up until the point at which we did the right thing “for” them by automatically enrolling them in these programs. One might have thought that their resistance was thoughtful, perhaps principled, and maybe economic—and yet, survey after survey shows that those who were defaulted in stayed there. Were they lazy, afraid to make the wrong decision, unable to make any decision, or merely inattentive? Perhaps all of the above. Regardless, the debate about whether we should “impose” on them our sense of the right thing to do—to make that decision for the “recalcitrant” minority—would seem to be over.

The New Frontier

The new frontier in participant decision-making appears to be retirement income or, more precisely, helping individuals make arrangements for a suitable stream of income post-retirement. There is a general—and perhaps increasingly pervasive—sense that the solution to this challenge is already at hand (or could be with a tweak here and there): the annuity.

That assumption was in evidence last week at a presentation by a panel of behavioral finance academics at an event sponsored by Allianz (1). As part of its response to the Labor Department’s RFI on retirement income, Allianz had worked with the inimitable Schlomo Benartzi to assimilate a wide range of behavioral finance techniques to better understand participants’ reluctance to embrace annuities (at least in large numbers), and to help remedy “the annuity puzzle” (yes, it even has a name, apparently). Certainly from an academic perspective, there is no valid reason why an individual seeking a dependable stream of income in retirement wouldn’t take advantage of a product that purports to do just that. And yet, in the “real” world, individuals continue to defy those expectations.

All of which, to my ears, began to beg the question, Should we be helping participants to do the “right” thing about retirement income, as we did about retirement plan enrollment? Should we be making that decision for them as well?

It is an idea that is already “out there,” and one that seems of interest to the Obama Administration. Certainly there is a concern that many take their multiple defined contribution distributions between “now” and whenever retirement finally occurs in cash and deploy them for purposes other than retirement. This “leakage” from the system almost certainly depletes the accumulative effect of retirement savings for many younger and lower-income workers, leaving them to literally start over at their next place of employment (there is some evidence that larger balances accumulated by older workers are more routinely rolled over into tax-advantaged vehicles such as an IRA).

Which again leads one to ask, what WOULD be the harm in letting a default mechanism make the “right” decision for them, certainly so long as they could opt out? Hasn’t our experience with automatic enrollment shown not only that people are willing to let good decisions be made for them, but that they appreciate it as well?

We once resisted automatic enrollment as a design choice for reasons that seemed just as daunting: We didn’t know the “right” deferral percentage, weren’t sure how it should be invested, worried that it would lose value between the time it was withheld and (potentially) returned, and were bothered by the potential conflicts between state wage law and federal directives. The Pension Protection Act effectively resolved those issues, provided a structure for a valuable safe harbor protection, and yet managed to avoid mandating its approach. As a result, it’s more likely than ever that more savers will have more savings to manage at retirement, perhaps for longer in retirement, than would otherwise be the case.

Now, for most situations at present, the retirement income amounts involved may well be too small, the products available too expensive and/or complicated, the protections for employers and participants alike too vague, the portability and/or access to the funds frustratingly problematic. And, let’s face it: Current annuity designs (2) don’t really come in a convenient “trial size.”

Still, IMHO, we need to focus on creating workable, sound default decisions—because the alternative for many until we do will be making decisions by default.


—Nevin E. Adams, JD

(1)All in all, it was a fascinating presentation, and the report summary that accompanied it is well worth a read (see “Annuities Get a Behavioral Finance Makeover” ). Those reports included notions that workers, and especially older workers, pay too much attention to recent stock market movements, suffer from a “hyper” aversion to risk, and, after their mid-50s supposedly have a particularly tough time making complex financial decisions. All of which purported to explain not only why workers don’t make good investing decisions at retirement, but perhaps even to suggest that they wouldn’t want to (ironically, one study indicated that, given the opportunity to make an active decision to purchase an annuity, a surprisingly robust 49% did).

(2)For the record, I’ve no particular affinity for the annuity concept per se vis-à-vis an alternative that provides the reliable stream of income at retirement for a reasonable price, and no reason to think that an adviser-led participant solution couldn’t compete very effectively with an annuity, much as an adviser-led investment program can do as well (and perhaps better) as a qualified default investment alternative. Of course, every participant doesn’t have access to an adviser, and many don’t have accounts large enough to warrant those attentions—and we need solutions for those participants as well.

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