Mark Rowlands: Using psychology to maximise pensions auto-enrolment

Mark Rowlands, corporate benefits marketing development director, Axa Corporate Benefits: While there are several technical flavours of automatic enrolment available in the market today, the core principle remains constant. That is, when you take on a new hire they automatically join the pension scheme unless they complete an application form to allow them to opt out.

If you use the traditional process, that is, getting employees to complete an application form to join, surprisingly, participation rates in pension schemes don’t rise dramatically. There are numerous surveys demonstrating this, but typical participation in schemes where automatic enrolment exists is over 90%. The clever thinking behind this comes from behavioural finance gurus who understood that the main reason why people didn’t join pension schemes on the traditional basis (opt-in) was simple inertia. They used this same psychological barrier in a positive way by relying on inertia to keep new hires in the pension scheme.

So far, so good. If your commercial objective is to secure a high participation rate, utilising automatic enrolment is a proven method to achieve your goals. However, this is not every employer’s objective.

The forthcoming government reform of pensions will introduce a new style of semi-compulsory pension known as Personal Accounts (PA). Currently scheduled to be introduced in 2012, the finer detail is still being finalised. However, we do know the broad themes, namely: the total contribution will be 8%, of which the employer pays 3%, all new hires will be automatically enrolled unless they opt out, employers with existing schemes will probably qualify for an exemption so won’t have to set up a separate scheme but in order to secure this exemption employers will have to match the minimum standards of personal accounts including automatic enrolment for new hires and possibly existing staff.

The net result of these reforms is that it is almost certain to increase bottom line pension costs as participation rates swell on the basis of automated joining.

As a leading global financial services business we have for several years investigated and operated automatic enrolment and other aspects drawn from behavioural finance.

The research and evidence from around the world demonstrates that automatic joining is a double edged sword, but it is superbly effective at increasing participation rates especially among younger, female and lower paid workers. Research co-authored by Yale professor James Choi entitled Defined contribution pensions – participant behaviour and the path of least resistance proved that employees who join automatically pay less than those who join on a traditional voluntary basis. The reason for this being that automated joiners enter at the set default level, typically between 3% and 5% in the UK currently and don’t engage in this decision-making process. Those who join on a voluntary basis have engaged to some extent in a conscious thought process including a decision on funding rate.

Another consequence of automated joiners is that the default settings are very sticky, by this I mean the funding rate and underlying fund choice are very rarely changed by employees. This raises a host of moral hazard-type issues for employers in setting these defaults, how much and which fund to choose as most employees will still be in these settings 20 years later. Research from mature DC markets and behavioural academics confirm this point and they help to explain it by the concept of mental accounting, employees have ticked the mental box, saying “pensions sorted”.

Engagement levels from employees on pensions are typically low, with automated enrolment they are set to become even lower. Employees who join automatically do not understand or value what is being provided for them, so it fails to secure a decent commercial return for the employer in terms of helping to recruit and retain staff. In an increasingly knowledge-based employment sector this is not satisfactory.

There are a number of solutions to this problem. Rather than see the increase cost as a burden, proactively communicate the benefits and value in what the employer is paying for. Instead of focusing on processes to enrol staff, use the time and budget to focus on the value of the pension scheme, the need for employees to engage and understand the generosity of the sponsor. One of the solutions from the behavioural experts is to expand the concept of automatic enrolment to include automatic increases on the employee’s contributions. Known as Save More Tomorrow plans, they utilise inertia to create an increasing contribution level, so those employees who don’t engage have the benefit of an increasing personal contribution rate over the next few years.

This concept works best in conjunction with ongoing communication in the workplace on the value of the pension benefits being provided. If you don’t communicate all you have is an increased cost with nothing to show for it.

Mark Rowlands, corporate benefits marketing development director, Axa Corporate Benefits

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