One assumption behind recent policy proposals, including the new proposed regulation to protect consumers is the importance of simplifying decisions. But does simplification work and does it help consumers? The answer from two academic projects is a resounding “yes.” I describe each of them below.
James Choi, David Laibson and Brigitte Madrian, researchers from both Harvard and Yale, study the effect of Quick Enrollment, a program that gives workers the option of enrolling in the employer-provided saving plan by opting into a preset default contribution rate and asset allocation. Unlike defaults, workers have the choice to enroll or not, but the decision is much simplified as they do not have to decide at which rate to contribute or how to allocate their assets.
When new hires were exposed to the Quick Enrollment program, participation rates in 401(k) plans tripled, going from 5% to 19% in the first month of enrollment. When the program was offered to previously hired non-participants, participation increased by 10 to 20 percentage points. These are large increases, particularly if one considers that the default rate is not particularly advantageous: the contribution rate in the most successful program is set at only 2%, with 50% of assets allocated to money market mutual funds and 50% allocated to a balanced fund. Moreover, Quick Enrollment is particularly popular among African-Americans and lower income workers (those earning less than $25,000) who, as the research mentioned before shows, are less likely to be financially literate. Thus, changes in pension design can have a significant impact on participation. Most importantly, this is a low-cost program.
Another approach designed to simplify the decision to save and, in addition, motivate employees to make an active choice is the one we did at Dartmouth College (this was a joint collaboration with a professor of marketing at the Tuck School of Business, the Executive Vice President of Finance and Administration at Dartmouth, and myself). We designed a planning aid to help employees contribute to supplementary pensions. The planning aid displays several critical features. First, it breaks down the process of enrolling in supplementary pensions into several small easy steps, describing to participants what they need to do to be able to enroll online. Moreover, it provides several pieces of information, such as describing the low minimum amount of income employees can contribute (in addition to the maximum) and the pension carriers employees can choose from. Such a simple and low cost intervention lead to a large increase in contribution rates to supplementary pensions; contribution rates doubled after the introduction of the planning aid. This program was targeted to women and low income employees; in the survey we distributed among employees, many respondents told us “they did not know where to start.”
This program shares several features with other programs. First, while economic incentives, such as employers’ matches or tax advantages may be useful, they do not exhaust the list of available options. Given the massive lack of information and financial knowledge, there may exist other and more cost-effective programs that can induce people to save; in fact, simplification is a rather unexploited way to affect decision-making. Second, employees are more prone to decision-making at specific times. For example, the start of a new job makes people think about saving (often because they have to make decisions about their pension). Both the papers by Choi, Laibson and Madrian and our paper find that new hires are particularly open to making changes. Third, to be effective, programs have to recognize the many differences that exist among individuals, not only in terms of preferences and economic circumstances, but also in levels of knowledge and financial sophistication.
So, here is a recommendation: make it simple!
A copy of the paper is available at: http://www.dartmouth.edu/~alusardi/Papers/Lusardi_Keller_Keller.pdf