Retirement Plans and Behavioral Economics
Hello Wallet Webinar
What Is Interesting About This Picture?
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Is It Just Our “Eyes” That Are Fooled?
Medvec, V.H., Madey, S.F., and Gilovich, T. (1995). When less is more: Counterfactual thinking and satisfaction among Olympic medalists. Journal of Personality and Social
Psychology, 69 (4), 603-610.
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Behavioral Economics Helps Explain
Neoclassical
Economics
The way people
should act
Behavioral
Economics
The way people
actually act
Psychology
Why people
act that way
“Behavioral economics is the
combination of psychology and
economics that investigates what
happens in markets in which
some of the agents display
human limitations and
complications.”
Mullainathan & Thaler, “Behavioral
Economics”, in the International
Encyclopedia of the Social and Behavioral
Sciences. Pergamon Press (2001).
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Behavioral Economics Forces at Work
Repeatable patterns we’ll cover today:
Anchoring
The IKEA
Effect
Loss
Aversion
The Power
of Nothing
Availability
Heuristic
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Anchoring
Definition:
We rely too heavily—or “anchor”—
on one trait or piece of information
when making decisions.
Sample research:
Participants were asked to first
write down the last two digits of
their social security number and
then asked how much they would
pay for different products
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Anchoring
Average prices paid for various products for each of five groups of final digits in
social security numbers
Range of last two digits of social security number
00–19
20–39
40–59
60–79
80–99
Cordless Trackball
$8.64
$11.82
$13.45
$21.18
$26.18
Cordless Keyboard
$16.09
$26.82
$29.27
$34.55
$55.64
Design Book
$12.82
$16.18
$15.82
$19.27
$30.00
Neuhaus Chocolates
$9.55
$10.64
$12.45
$13.27
$20.64
1998 Cotes du Rhone
Wine
$8.64
$14.45
$12.55
$15.45
$27.91
1996 Hermitage Wine
$11.73
$22.45
$18.09
$24.55
$37.55
Source: Dan Ariely, George Lowenstein, and Drazen Prelec “Coherent Arbitrariness: Stable Demand Curves and Stable References,”
Quarterly Journal of Economics (2003)
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Percentage of People Who Were Organ Donors
98
100
99.98
99.91
99.997
99.5
99.64
Effective Consent Rate (%)
85.9
80
60
40
27.5
17.17
20
12
4.25
0
Source: Eric Johnson and Daniel Goldstein “Defaults and Donation Decisions,” Transplantation, Vol. 78, No. 12, pp. 1713-1716 (2009)
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Anchoring: Does Automatic Enrollment Help?
vs.
average participation
rate for those who were
not subject to A.E.
average participation
rate for those who were
subject to A.E.
Source: Aon Hewitt 2014 Universe Benchmarks
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Anchoring: Does Automatic Enrollment Hurt?
vs.
average savings of
participants who were
not subject to A.E.
average savings of
participants who were
subject to A.E.
Source: Aon Hewitt 2014 Universe Benchmarks
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Default Rates for Automatic Enrollment
60%
49%
50%
40%
30%
20%
9%
10%
12%
13%
14%
4%
5%
6% or more
3%
0%
1%
2%
3%
Source: Aon Hewitt 2013 Trends & Experience in Defined Contribution Plans
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Default Rates for Automatic Enrollment
Saving 1.3% less over
career leads to
20%
less retirement savings
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Loss Aversion
Definition:
Avoiding Losses > Acquiring Gains
I hate losing. I hate it. I hate losing more than I even wanna win.
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-Brad Pitt as Billy Beane Moneyball
13
Loss Aversion
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Loss Aversion
Average Selling/Buying Ticket Price
$3,000
$2,500
$2,400
$2,000
$1,500
$1,000
$500
$175
$0
Winners
Losers
Source: Ziv Carmon and Dan Ariely, “Focusing on the Forgone: How Value Can Appear so Different to Buyers and Sellers,” Journal of
Consumer Research (2000)
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Recent Example of Loss Aversion – Aon Hewitt 401(k) IndexTM
2030
0.070%
2010
0.060%
1990
0.050%
1970
1950
0.040%
1930
0.030%
1910
0.020%
1890
0.010%
1870
1850
Net Activity as % of Balance (RHS)
S&P 500 Closing Value (LHS)
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10/31/2014
10/30/2014
10/29/2014
10/28/2014
10/27/2014
10/26/2014
10/25/2014
10/24/2014
10/23/2014
10/22/2014
10/21/2014
10/20/2014
10/19/2014
10/18/2014
10/17/2014
10/16/2014
10/15/2014
10/14/2014
10/13/2014
10/12/2014
10/11/2014
10/10/2014
10/9/2014
10/8/2014
10/7/2014
10/6/2014
10/5/2014
10/4/2014
10/3/2014
10/2/2014
10/1/2014
0.000%
Recent Example of Loss Aversion – Aon Hewitt 401(k) IndexTM
100%
to Equities
2030
2010
1990
1970
1950
0%
1930
1910
1890
1870
Direction and Power of Trades (RHS)
S&P 500 Closing Value (LHS)
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10/31/2014
10/30/2014
10/29/2014
10/28/2014
10/27/2014
10/26/2014
10/25/2014
10/24/2014
10/23/2014
10/22/2014
10/21/2014
10/20/2014
10/19/2014
10/18/2014
10/17/2014
10/16/2014
10/15/2014
10/14/2014
10/13/2014
10/12/2014
10/11/2014
10/10/2014
10/9/2014
10/8/2014
10/7/2014
10/6/2014
10/5/2014
10/4/2014
10/3/2014
10/2/2014
10/1/2014
1850
‐100%
to Fixed Income
Loss Aversion: Application to Investing
Actual Investor Averages:
Benchmarks:
5.02% 9.22%
Equity Return
S&P 500 Return
0.71% 5.74%
Bond Return
Barclay’s Aggregate Bond Index
Source: DALBAR 2014 Qualitative Analysis of Investor Behavior showcasing returns for individuals in the 20 years ending on 12.31.2013
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The IKEA Effect
Definition:
Increasing labor increases
appreciation
Sample research:
How much does creating a
product influence how much
you’d pay for it?
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Price Offered
The IKEA Effect
Source: Norton, M., Mochon, D. & Ariely, D. (2011). The “IKEA Effect”: When Labor Leads to Love. Harvard Business School Working Paper.
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The IKEA Effect: Example
Default
Adopt a strategy to
aggressively encourage
“opt-ups” in DC
contribution rates
Opt Up
Create a better outcome
New Hire
Increasing your contribution rate to 10% from the default
of 3% helps put your financial future on more solid
footing.
The sooner you start saving
10%–the farther your money goes
Example:
Promote an opt-up of
10% rather than standard
3% with 1% contribution
escalation.
$149,700
$122,300
$79,800
$59,300
After
5 years
10 years
15 years
$32,000
$18,000
5 Years
10 Years
15 Years
Now it’s up to you
Check YES on the reply card below, and then sign it and
return it in the enclosed postage-paid envelope.
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Balance
78% more
35% more
22% more
Be Careful With the Choices
Group 1
Group 2
Patient
67 year old
67 year old
Medicine
Already Tried
Aspirin,
Naproxen,
Ketaprofen
Aspirin,
Naproxen,
Ketaprofen
Original
Decision
Hip
replacement
Hip
replacement
New
Treatment
Ibuprofen
Ibuprofen OR
Piroxicam
Percent Using
New
Treatment
72%
53%
Source: Redelmeier, D. & Shafir, E. “Medical Decision Making in Situations That Offer Multiple Alternatives,” Journal of the American Medical
Association, Vol. 273, No. 4, pp. 302-305 (1995)
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The Power of Nothing
Definition:
Free is a special price and blows up
traditional economic theory.
Would you get a tattoo if it were
free?
In one study 68% of people who
would normally not get a tattoo got
one solely because it was free
Source: Dan Ariely, “The Power of Free Tattoos,” Predictably Irrational Blog (2011)
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Which Would You Choose?
Case 1:
27 cents
2 cents
Case 2:
26 cents
1 cent
Case 3:
25 cents
Free
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The Power of Free
Proportions of Consumers Choosing Hershey’s and Lindt Chocolate
Across the Three Experimental Conditions
100%
Percent Choice
80%
10%
40%
40%
15%
20%
60%
40%
20%
Lindt
90%
Nothing
Hershey's
45%
40%
2 and 27
1 and 26
0%
0 and 25
Condition
Source: Kristina Shampanier, Nina Mazar and Dan Ariely (2007) “Zero as a Special Price: The True Value of Free Products”. Marketing
Science. Vol. 26, No. 6, 742–757.
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The Power of Nothing—Application to DC Plans
Survey to DC Participants
“Savings too low”
⅔
14% Increase
35% “Plan to Increase”
“Savings about right”
⅓
Source: Choi, J., Laibson, D., Madrian, B., and Metrick, A.; Defined Contribution Pensions: Plan Rules, Participant Decisions, and the Path of Least
Resistance; November 2001
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We Use Mental Shortcuts
A cup of coffee and a newspaper together cost $3.50. The coffee costs $1.00
more than the newspaper.
How much does the newspaper cost?
$________
$________
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Availability Heuristic
Definition:
One’s judgment of an event is
influenced by how readily an
example comes to mind
“If you can think of it, it must be
important”
Source: Esgate, A. & Groome, D. (2004). An Introduction to Applied Cognitive Psychology. New York: Psychology Press.
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Availability Heuristic: Application to DC Plans
of DC participants invest
in their company stock
when it is available
of all investment dollars
are in individual
company stock when
available
Source: Aon Hewitt 2014 Universe Benchmarks
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Availability Heuristic: Application to Investing
Stocks
Bonds
When shown 1 year returns
When shown 30 year returns
Source: Bernartzi and Thaler, Risk Aversion or Myopia, Choices in Repeated Gambles and Retirement Investments
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Putting it Together

Research focused on when individuals
commence Social Security retirement
benefits

Does the framing of communication
influence the result?
In following examples, look for instances
of
– Anchoring
– Loss aversion

Source: Brown, J., Kapetyn, A, & Mitchell, O. (2011). Framing Effects and Expected
Social Security Claiming Behavior. Working Paper: National Bureau of Economic
Research
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Example One
When you claim your Social Security benefit, you will begin receiving a monthly benefit payment. You have
the option of claiming anytime between age 62 and age 70. Because of how Social Security benefits are
calculated, on average people receive about the same amount in total lifetime payments no matter when they
start receiving
benefits.
Therefore
the Social
Security
system’s
unaffected,
average,
by when
Suppose
that
you claim
your
benefit
at age
66.finances
In thisarecase
you on
will
receive
people claim benefits.
$2,065.00 each month. You will receive this amount every month for as long
much
youand
receive
each
month depends
on your with
age when
you claim.
asHow
you
live,
the
amount
will adjust
inflation
each year to preserve
purchasing
power.
Suppose that you claim your benefit at age 66. In this case you will receive $2,065.00 each month. You will
receive this amount every month for as long as you live, and the amount will adjust with inflation each year to
purchasing
If preserve
you claim
one power.
year earlier, at age 65, your benefit would be $1,927.00 per
month.
If you
claim
one
year
at age
your benefit
would
$2,230.00
If you claim
one year
earlier,
at age
65, later,
your benefit
would67,
be $1,927.00
per month.
If yoube
claim
one year
later,
at age 67, your benefit would be $2,230.00 per month.
per
month.
Based on the information provided on this page, at what age would you claim your Social Security retirement
benefits? Move the slider to select an age and see what your monthly benefits will be.
62
63
Age:
66
Month:
February
Monthly benefits: $
64
65
66
67
68
2,065
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69
70
Example Two
When you claim your Social Security benefit, you will begin receiving a monthly benefit payment. Because of
Suppose
that you
claim
your benefit
at age
62.
In this
youamount
will receive
how Social Security
benefits
are calculated,
on average
people
receive
aboutcase
the same
in total lifetime
payments no matter
they start
receiving
benefits. Therefore
the Social
Security
system’s
are
$1,549.00
eachwhen
month.
You
will receive
this amount
every
month
forfinances
as long
unaffected, on average, by when people claim benefits.
as you live, and the amount will adjust with inflation each year to preserve
How much you receive each month depends on your age when you claim.
purchasing power.
Suppose that you claim your benefit at age 62. In this case you will receive $1,549.00 each month. You will
receive this amount every month for as long as you live, and the amount will adjust with inflation each year to
purchasing
power. your monthly will increase. For example, if you claim
Ifpreserve
you delay
claiming,
your
benefits
at your
agemonthly
63 (one
year later),
your ifbenefit
by63$103.00
If you delay
claiming,
will increase.
For example,
you claimwill
yourincrease
benefits at age
(one year
later),
your benefit
will increase byHowever,
$103.00 per month
to $1,652.00.
However,
by delaying
youryear,
benefityou
by one
per
month
to $1,652.00.
by delaying
your
benefit
by one
year, you will forfeit the $18,588.00 that you would have received between age 62 and 63. By our calculations,
will
forfeit
theto $18,588.00
thatyears
youin would
have
between
age
62 and
you would
need
live at least 15 more
order to get
back received
the $18,588.00
you forfeited
by waiting
one
year.By our calculations, you would need to live at least 15 more years in
63.
Based on
provided
on this page,
at what
age would
claim your
Social
Security retirement
order
tothe
getinformation
back the
$18,588.00
you
forfeited
byyouwaiting
one
year.
benefits? Move the slider to select an age and see what your monthly benefits will be.
62
63
64
65
66
67
Age:
62
Monthly increase relative to claiming at age 62: $
Month:
February
Total amount forfeited by not claiming at age 62: $
Monthly benefits: $
1,549
68
Number of years required to break-even:
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69
70
Example Three
By claiming
younger
youSocial
reduce the
monthly return
on your
The
latest atyou
canages,
claim
Security
benefits
iscontributions.
age 70, but Social
Security’s
“normal retirement age” is age 66. If you claim at 66, based on your
The latest you can claim Social Security benefits is age 70, but Social Security’s “normal retirement age”
contributions,
Social
willcontributions,
return $2,065.00
to you
each$2,065.00
month.to You
will
is age 66. If you claim
at 66,Security
based on your
Social Security
will return
you each
month. You
will receive aevery
paymentmonth
every month
youturn
turn age
for as
you live,
receive
a payment
afterafter
you
age6666
forlong
asaslong
as and
youthelive,
amount will adjust with inflation each year to preserve the purchasing power of this return. If you claim
and
the
amount
will adjust
with inflation
eachreturn
year
the purchasing
earlier
than
this—as early
as age 62—your
Social Security
willto
bepreserve
cut.
power of this return. If you claim earlier than this—as early as age 62—your
For example, if you start your benefit at age 65 (one year earlier than the normal retirement age), the
Social
return
will Security
be cut.falls by $165.00 per month to only $2,230.00. If you start your
amountSecurity
you get back
from Social
benefit at age 62, the amount you get returned to you falls by $516.00 to only $1,549.00 per month.
For
example, if you start your benefit at age 65 (one year earlier than the
The reduced return on you contributions is permanent, so you will have less money returned to you each
normal
age),
month forretirement
the rest of your
life. the amount you get back from Social Security falls by
$165.00 per month to only $2,230.00. If you start your benefit at age 62, the
Based on the information provided on this page, at what age would you claim your Social Security
amount
get returned
to you
falls
toyour
only
$1,549.00
per
retirementyou
benefits?
Move the slider
to select
an by
age $516.00
and see what
monthly
benefits will
be.month.
62
63
Age:
66
Month:
February
Monthly benefits: $
64
65
66
67
68
How much you get more per month than when you claim at 66: $
2,065
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69
0
70
How Did Framing Influence the Results?
Commencement Age Selected
68
67
67.5
67
66
65
64
64
63
62
Example 1: Neutral
Example 2: Breakeven
Example 3: Loss
Source: Brown, J., Kapetyn, A, & Mitchell, O. (2011). Framing Effects and Expected Social Security Claiming Behavior. Working
Paper: National Bureau of Economic Research
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Putting it Together: The Auto(k) Plan
Anchoring
Loss
Aversion
The IKEA
Effect
The Power
of Nothing
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Availability
Heuristic
The Auto(k) Plan
Applying Dynamic Investing to DC Plans
 Plan automatically adjusts contribution rate (and, potentially, investment mix)
based on a target savings goals with short-term milestones
 There would be a default savings milestones, but an employee could adjust
those milestones by setting a different retirement target
Here’s how it would work:
1
Set long-term
savings target by
showing perils of
inadequacy
2
Create short-term
goal based on longterm target
3
Establish initial
savings rate and
investment mix to
meet short-term goal
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4
Periodically re-balance
savings rate or
investment mix based
on measurement
against short-term goal
The Auto(k) Plan
Example:
Target Accumulation
At Start
Age
Long-term Target
Short-term
Savings Rate
25
12 x pay (age 65)
Goal 0.7 x pay (age 30)
12.5% pay
Multiples of Pay
0.8
0.7
0.6
0.55
0.4
0.4
0.2
0
0.26
0.13
26
27
28
29
30
Age
 Assess after 2 years:
– If below target of 0.26 x pay—increase contribution rate
– If above target of 0.26 x pay—decrease contributions
Note: Could also increase equity exposure up or down depending on outcomes
Product Strategy and Development | Retirement | Retirement Plans and Behavioral Economics
Proprietary and Confidential | December 2014
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON).
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The Auto(k) Plan
Concept
Application
Anchoring
Establish big long-term goal first
Loss Aversion
Illustrate ill effects of inadequacy
IKEA Effect
Employees need to sign up for Auto(k) Plan
Power of Nothing
Once established, the Auto(k) Plan requires little
attention
Availability
Heuristic
Employees can easily see if their savings are “ontrack”
Product Strategy and Development | Retirement | Retirement Plans and Behavioral Economics
Proprietary and Confidential | December 2014
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON).
39
Contact List
Rob Austin
Director of Retirement Research
+1.704.343.4154
[email protected]
Product Strategy and Development | Retirement | Retirement Plans and Behavioral Economics
Proprietary and Confidential | December 2014
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON).
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Legal Disclaimer
© 2014 Aon plc
This document is intended for general information purposes only and should not be
construed as advice or opinions on any specific facts or circumstances. The comments in
this summary are based upon Aon Hewitt's preliminary analysis of publicly available
information. The content of this document is made available on an “as is” basis, without
warranty of any kind. Aon Hewitt disclaims any legal liability to any person or organization
for loss or damage caused by or resulting from any reliance placed on that content. Aon
Hewitt reserves all rights to the content of this document.
Product Strategy and Development | Retirement | Retirement Plans and Behavioral Economics
Proprietary and Confidential | December 2014
Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON).
41