Monday, February 23, 2009

Nudging in pension savings

Mostly Economics draws attention to default choices in pension plans initiated under the New Pension Systems (NPS) formulated by the Pension Fund Regulatory and Development Authority (PFRDA). Under the defined contribution system of pension plans, the employees have the option of choosing between a bouquet of investment alternatives (equities, bonds etc) and apportioning the investments among the selected investment instruments. Sweden has been running such default savings scheme (research paper here) in its partially privatized social security plans.

It has been proved from research across the world that employees often find it difficult to make the choice between a whole host of competing investment portfolios. In the circumstances, appropriately tailored "default choices", which vary for people of different ages, assume significance. Under the NPS, funds that fall under auto choice should be distributed equally amongst Pension Fund Managers (PFMs) and those that perform better (low costs higher returns) should be replaced.

In this context, the PFRDA could go even further and look at the widely acclaimed example of the Save More Tomorrow (more here, here, and here) savings scheme formulated by Richard Thaler and Shlomo Benartzi that allows employees to allocate a pre-defined portion of their future salary increases toward retirement savings as a default option in their pension or savings plans.

Such social nudges achieved by appropriately tailoring the choice architecture so as to get people to do what they would want to (or are in their interests) but are not able to do, for various reasons, have been tried out in various other areas. Another example is the Give More Tomorrow program where people contributing monthly to some social or charitable causes are nudged to commit a small incrementally increasing sum.

No comments: