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Behavioral Economics: How Participants Make Decisions NCPERS 2015 ANNUAL CONFERENCE Jim Potvin, Employees' Retirement System of Georgia Wendy Carter, Segal Copyright © 2015 by The Segal Group, Inc. All rights reserved.

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Behavioral Economics: How Participants Make DecisionsNCPERS 2015 ANNUAL CONFERENCEJim Potvin, Employees' Retirement System of GeorgiaWendy Carter, Segal

Copyright © 2015 by The Segal Group, Inc. All rights reserved.

1

Who Do You Select as a Fund Manager?

Manager A Manager B

Assets Under Management $20 Billion $7.2 Million

Clients Over 100, including sophisticated investors and

well-known families11 Doctors

Results Average annual 10 years of 25%; volatility 2% / year

Average annual 6 years of 25%; volatility 14% / year

Portfolio Basket of S&P 100 stocks with options strategy 30 – 40 stocks

Offices New York and London Omaha, Nebraska

2

Answer

HERDING BIAS: Gravitating to an investment opportunity based principally on the fact that many others are doing so

Manager ABernie Madoff, 2001

Manager BWarren Buffett, 1962

3

Spending little time planning for retirement, reviewing progress—a majority regret their decisions

Not estimating retirement income needs

Not making (or increasing) voluntary contributions, especially when there is a match

Under-choosing target date funds

Under-selecting annuities

Over-reacting to the latest stock market report

Not taking advantage of employer-provided educational resources: Educational materials and presentations Income and contribution calculators Investment guidance, advice and/or managed advisory services

Sub-optimal Participant Behaviors

4

System 1: Fast Automatic; requires little effortExamples: Eat the doughnut in front of you

Answer that text that just arrived

Why Is Changing Behavior So Hard?

System 2: SlowReflective; involves choice and concentrationExamples: Deciding how much to save for retirement

Re-evaluating your investment strategy

* Thinking, Fast and Slow by Daniel Kahneman, 2011

5

“Behavioral economics is the study of how real people actually make financial choices; it draws on insights from both psychology and economics.”

Research based critique of rational decision theory

The science of trying to understand how and why individuals make suboptimal and optimal consumer choices

What is Behavioral Economics?

Stockholm’s Piano Subway Staircase makes musical sounds as you walk on it. 66% increase in people choosing stairs

Definition: The Marketplace of Perceptions: Behavioral economics explains why we procrastinate, buy, borrow, and grab chocolate on the spur of the moment. Craig Lambert, Harvard Magazine. March – April 2006

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Be intentional about the choice architecture used to ensure it recognizes the employees’ mental shortcuts and shapes the desired behaviors.

Leveraging Behavioral Economics

Choice ArchitectureFramingNamingOrderingDefault OptionsPrimingAnchoringFoot in the DoorBehavioral Messaging

Heuristics are mental shortcuts every person uses every day in decision-making. It is intuitive thinking; it’s very easy, very fast and automatic.

HeuristicsEndowment EffectLoss AversionStatus Quo BiasClue Seeking BiasExpert’s Certainty BiasPreference for Now vs. FutureSentinel Event SensitivityOptimism Bias

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What Causes Sub-optimal Decision-Making

My former boss chose the annuity at retirement and died young. I won’t make the same mistake—give me the lump sum!

Sentinel Event Bias

Look at all of these investment options. Well, the Company must have put the Money Market Fund at the top of the list for a good reason. I will choose it.

Complexity Aversion and Clue Seeking Bias

Mental Shortcuts asBARRIERS TO CHANGE Examples with Retirement Plans

I can spend that 3% of salary on vacation in Orlando or put it away in the 401(k). What is the big deal anyway about compound interest?

Hyperbolic Discounting

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Tapping Biases to Improve Decision-MakingMental Shortcuts asBRIDGES TO CHANGE

Are you concerned about: Outliving your financial nest egg? Dying young and losing most of your

pension? Click here for the Hybrid Distribution Option!

Overvaluing Low Probability Events

Everywhere I look I see messages about “saving for tomorrow,” “tax deferral” and “rising investor confidence.”

Availability Heuristic

Nudging & Simplicity (use obvious cues) Wealth Building Fund for People Your Age Click here for: Participant Directed,

Expert Investor Options

Clue Seeking Bias

Examples with Retirement Plans

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Shoppers who

stopped40% 60%

Shoppers who bought

jam30% 3%

6kinds of jams

24kinds of jams

Iyengar & Lepper (2000)

Things That Make You Go “Hmmm…”

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Things That Make You Go “Hmmm…”Question: What percent of United Nations member countries are on the African continent?But before answering, spin the wheel of fortune

Tversky & Kahneman (1971)

Mean answer:

45%

Mean answer:

25%

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Present Bias—Immediate events get full weight; future events are discounted

If you are selecting a snack to eat NEXT WEEK, which would you choose? 74% choose…

If you are selecting a choice to eat TODAY, which would you choose? 70% choose…

Psychological Origins of Undersaving

Source: Phelps and Pollk (1968); Akerlof (1991), Laibson (1997)

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3 actually follow

through

3 actually follow

through

24 plan to raise savings rate in the next 2 months

24 plan to raise savings rate in the next 2 months

68 self-report saving too little68 self-report

saving too little

Why do savers procrastinate?

If I join the DC Plan today, I suffer 100% of the sign-up hassles. The hassles appear smaller if I plan to join next month

I’ll have more free time next month

My family is living paycheck to paycheck right now. Our finances will be in better shape next month

Saving Intentions

Out of every 100 employees

surveyed

Out of every 100 employees

surveyed

(Laibson)

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How do we help a 30 year old view what their life will be like at age 70?

Encouraging People to Save

Participants who saw their FUTURE selves contributed 6.2% toward retirement

Participants who saw their CURRENT selves contributed

4.4% toward retirement

Source of Data: “Increasing Saving Behavior Through Age-Progressed Renderings of the Future Self,” Hal E. Hershfield, et al, Journal of Marketing Research Vol. XLVIII, S23–S37, November 2011

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Auto-enrollment At date of hire Annually to greater of default rate or actual contribution rate

Auto-escalation With pay raises Annually

Default Investments Target date funds Balanced funds Managed accounts

Hybrids EZ enrollment using

– default contribution rate– auto-increase– both

Countering Present Bias

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Framing -Hinder or Help Savings Rates

Anchor attention toward the higher savings rates.

Emphasize loss with lower savings rates.

Revised DC Plan Choice Structure 50% Match up to 6% of Pay

Employee Savings

Employer Contribution

Total Contribution

Lost Employer

Match12% 3% 15% 0%10% 3% 13% 0%8% 3% 11% 0%6% 3% 9% 0%4% 2% 6% 1%2% 1% 3% 2%0% 0% 0% 3%

Behavioral Economic Solution

Implied Messages Any contribution other than 0% is good

The right amount to save is 6% because the company caps its match at 6%

A total contribution at 9% of pay is sufficient for retirement readiness

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Case Study: Auto Enroll and Auto Escalation

77%

6%

54%

95%

7%

64%

0%

20%

40%

60%

80%

100%

Participation AverageDeferral

RetirementReadiness

Before After

Participation and Retirement Readiness

Plan Configuration Defined Benefit Pension Plan

1.25% x Final Avg. Pay Defined Contribution Plan

50% Match up to 6% of Pay

New Auto Contribution

Current Year Contribution Rate

New Year Auto

Contribution Rate0%, 1% or 2% 3%

3% - 5% 4% - 6%6% + No Change

Results Over a Six Year Period Dramatic increase in DC participation Increase in average deferrals Increase in retirement readiness

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Employees’ Retirement System of Georgia

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ERS first tier (“Old Plan”) and second tier (“New Plan”) were primarily DB plan benefits 457 and 401(k) plans offered as supplemental savings plans

Current tier – Georgia State Employees Pension and Savings program (“GSEPS”) New hires on and after 1/1/2009 Not hybrid, but two core retirement plans

– Smaller DB formula– 401(k) includes employer matching contribution– 457 still available as supplemental plan

Shared responsibility – state no longer solely responsible for determining final retirement benefit Very significant culture change

Background

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Automatic participation in DB plan 1% x FAP x high 24; 1.25% employee contribution

401(k) plan Auto enrollment (“opt-out”) Default investment in age-appropriate Lifecycle Fund Employer match

– 100% on first 1%– 50% on 2-5% (max 3% match on 5% contribution rate)

Default employee contribution rate of 1% Auto escalation on opt-in basis

GSEPS – Key Features

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Web site – significant education and transactional functionality

Handbooks / pamphlets

Local HR staff

Advice services offered via third party through our TPA

Nearly unlimited flexibility for members to manage their accounts

Investment options Contribution rate, including 0% Level of advice / assistance

GSEPS – Tool Set

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Changes:

Integrate 401(k) savings election with Flex Benefits O.E. Net 5,000+ members increased savings rate each year since 2012

Add targeted communications to annual DC statement

Initial Results7/1/2012

# of GSEPS Members 15,600% of Active Mbrship 24%Participation Rate 90%Contrib Rate: 0% 10%Contrib Rate: 1% 71%Contrib Rate: 5% + 11%% in Lifecycle Fund >90%

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Changes / Activity:

Redesign enrollment Initial elections / opt-out must occur on web site

– “Push” education– Quick enrollment options (nearly 1,800 elections 7/1/2013 to date)

July 2013 – behavioral audit report

One Year Later7/1/2012 7/1/2013

# of GSEPS Members 15,600 18,700% of Active Mbrship 24% 30%Participation Rate 90% 89%Contrib Rate: 0% 10% 11%Contrib Rate: 1% 71% 64%Contrib Rate: 5% + 11% 14%% in Lifecycle Fund >90% >90%

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Change:

Default contribution rate increased to 5% for new hires, effective 7/1/2014

Two Years Later7/1/2012 7/1/2013 7/1/2014

# of GSEPS Members 15,600 18,700 22,200% of Active Mbrship 24% 30% 37%Participation Rate 90% 89% 91%Contrib Rate: 0% 10% 11% 9%Contrib Rate: 1% 71% 64% 57%Contrib Rate: 5% + 11% 14% 22%% in Lifecycle Fund >90% >90% >90%

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Current

7/1/2012 7/1/2013 7/1/2014 3/1/2015# of GSEPS Members 15,600 18,700 22,200 25,100% of Active Mbrship 24% 30% 37% 41%Participation Rate 90% 89% 91% 91%Contrib Rate: 0% 10% 11% 9% 9%Contrib Rate: 1% 71% 64% 57% 38%Contrib Rate: 5% + 11% 14% 22% 42%% in Lifecycle Fund >90% >90% >90% >90%

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Changes:

Financial literacy seminars (fall 2014)

Integrated DB / DC annual benefit statements (winter 2016)

Future-dated enrollment / escalation (proposed)

As of 3/1/2015

Hired < 7/1/14 Hired > 6/30/14Contrib Rate: 0% 10% 7%Contrib Rate: 1‐4% 64% 9%Contrib Rate: 5% + 26% 84%

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Thank you!