This is a worldwide problem but some nations have been more successful than others at addressing the issue. In America there have been some startling results from the adoption of a scientific approach to encouraging group scheme members to make higher contributions.
Adopting an approach developed by Professor Shlomo Benartzi of the University of California in Los Angeles and Professor Richard Thaler of the University of Chicago known as ‘Save More Tomorrow’, some schemes have seen increases as high as 250 per cent of contributions in the 40 months after an SMT option was introduced. The findings of their investigation into the use of behavioural economics to encourage greater levels of pension contribution make fascinating reading for anyone involved in pension sales.
SMT works by encouraging pension scheme members to decide to take action in the future which will increase their pension contributions even if they are not going to make the increased payments immediately. Employees are encouraged to agree to future increases in contributions to coincide with annual pay rises so that the effect of the additional payment is masked rather than representing a sudden reduction in net pay.
Employers are of course also en-couraged to make matching contributions and auto enrolment is not surprisingly strongly advocated. In a 2006 study the authors identified after analysis that 13 schemes had a typical participation rate of 13 per cent; this rose to 90 per cent after the introduction of auto-enrolment.
To reduce employee resistance an important part of the SMT approach is that members can cancel the additional contribution at any time; this is likely to be particularly important in the current economic climate. Where arrangements are still set up on a commission basis the attractions to the adviser firm are obvious, but equally taking such an approach should be attractive to those employers who see providing a pension scheme as a key way of attracting and retaining staff.
Such is the success of SMT that the Department of Work and Pensions is currently conducting research into its effectiveness. A number of UK pension providers now offer SMT as an option including Axa, which has designed a range of dedicated collateral to encourage its adoption. They are able to support the SMT approach as well as producing illustrations which include the effect of future SMT-based increases to contributions.
I recently had the opportunity to look at a preview version of a pension calculator they will be making available to scheme members in about a month’s time, to help consumers understand the potential benefits of an SMT approach. This allows users to compare their current pension benefits with the benefits they would receive if they increased their contributions using a SMT approach.
The simple web-based software tool enables users to compare the effect on their pension of increasing contributions by a percentage or a fixed amount, as well as showing the effect of setting up regular automatic increases over a number of years and lump sum contributions. Users can also employ the tool to identify the effect of changing a retirement date. The responses are played back to the user both as graphs and numbers making it very easy to understand. Calculators of this type are nothing new but have been demonstrated to be a highly effective way to encourage people to increase their pension contributions.
SMT helps members save in a range of ways. By committing up front to action it removes a natural inertia to increased contributions, avoiding the temptation to put off to next year action which would in the long run be beneficial for them. Equally, they are less likely to decide to spend money on a holiday as an alternative to increasing pension contributions. While they are free to withdraw from the additional contributions at any time, in practice they are less likely to do so.
Modern consumers seem to have a natural resistance to saving. The financial services market could gain a great deal by having a better understanding of how and why, from a psychological perspective, consumers reach decisions. Analysis of this type can provide an invaluable insight to consumer behaviour and seems an excellent example of what can be done if we think smarter.