Simplifying the joining process

Ignorance of how pensions work and the complexity involved in joining a scheme can lead to procrastination and the potential member doing nothing, argues Jo Cann... Providing financial education, using automatic enrolment and simplifying the joining process can all help.

But, combining all these features together possibly has the greatest impact to overcome inertia and encourage enrolment in the pension scheme.

Iyengar and Kamenica (2006)1 demonstrated that simplification raises participation. In particular they found that employees are overwhelmed by too much choice especially around funds, which tended to lead to lower participation rates. I first wrote about this in my column in August 2007.

Enrolment in the scheme typically involves a number of decisions; whether to join, how much to save, which funds to invest in, and what increase rate to select.

Beshears et al have investigated a simplified joining process, which involves one decision – whether to join or not. Those who join automatically receive a default saving rate and default fund selection.

The results in the table demonstrate that simplifying the joining process enhances scheme participation. The joining rates increased from 5% to 19% for people with one month of employment, compared with 10% to 35% with four months of employment.

An important point to note is once in a pension plan, members tend to stick to the default fund and savings rate selected. Careful selection of a default fund is important in this context, especially as members are unlikely to switch funds after the initial selection.

I have written previously about Save More Tomorrow, which can be selected at outset to ensure savings rates increase periodically over the course of the plan.

In fact, simplification could be extended to include more decisions at outset; decision to join the plan, a small number of options on savings rates (for example 3%,5%,10%), default funds based on attitude to risk or retirement age, and annual increase in savings rates. Joining processes could be redesigned to make these decisions simpler whilst keeping the number of choices to a minimum.

By eliminating the multiple decisions required or reducing the number of decisions required at joining, participation rates will increase. Whilst less dramatic than automatic enrolment, simplification still has a part to play in helping increase scheme participation.

1 The Psychological Costs of Ever Increasing Choice: A Fallback to the Sure Bet, by Iyengar and Kamenica (2006) – used a large dataset of 800,000 employees, and showed that the greater the choice of funds, the lower the participation rate, suggesting employees are overwhelmed by too much choice and complexity.