Build a Better Plan With Better Choices

A good plan uses the right architecture, and the right architecture factors in steering the behavior of participants, a paper says.

Behavioral economics and “choice architecture” are essential tools that plan advisers can use to help plan sponsors improve retirement readiness, says Christopher Goldsmith, vice president of Sibson Consulting, a provider of HR benefits, compensation, and talent and performance management.

Advisers should keep in mind the difference between extrinsic and intrinsic motivation when working with plan sponsors. “The ability to retire on a certain income is an extrinsic motivator,” Goldsmith explains. But when the talk turns to people outliving their assets and becoming a burden on society, then advisers can appeal to the intrinsic reward that strikes a chord with plan managers. “You have to appeal to people emotionally,” Goldsmith says. “That is what creates behavioral change.”  

Sibson has previously issued white papers that discuss how behavioral economics can educate employees. Plan architecture  can specifically encourage (or discourage) employee engagement in the plan, Goldsmith tells PLANADVISER. “Everyone responsible for participant communications is a choice architect, whether they know it or not,” he says.

Improving communication is an opportunity, according to Goldsmith.  “Plan advisers ought to look at the state of retirement readiness in America and recognize there is great room for improvement in plan sponsor decisions and participant communications,” he points out.

Effective communication is influenced by human biases in both the senders and receivers of messages, according to Goldsmith. “Each consumer financial decision is a product of rational, emotional, deductive and inferential reasoning,” he says. “Effective choice architecture recognizes that emotional and inferential reasoning are at play. Ineffective choice architecture assumes all participants thoroughly research alternatives and deduce the best option for their personal circumstance.”

A one-size-fits-all communication campaign is unlikely to achieve anywhere near optimal results, according to research by Sibson. Participants have a range of desires and goals. Some seek strong returns, while others seek capital preservation. Some participants have time and energy for personal research, while others rely on the defaults offered in a plan. Some participants have expertise in investing and finance, and others are financial neophytes.

As a result, Goldsmith says, the firm is beginning to study how to use variable choice architecture that factors in human biases and preferences. The best kind of communication varies the content and the way it is framed to suit different participants while still meeting compliance requirements.

Compliance Drives Messaging

“Many plan sponsors are anchored in the way they have been communicating and doing business for years,” Goldsmith says. “Their messaging is premised on the rational investor model and legal compliance concerns. That style of messaging has been positively reinforced by legal counsel and actuarial advisers for decades.”

Of course some of this is critical, he says, and it is important to keep on top of meeting regulator concerns. But so much communication is not participant friendly. A good example is the language used to describe distribution options, according to Goldsmith.

Participants are given a barrage of legalese—about annuities, joint survivor benefits, lump-sum distributions—to decode. The language and choices can be ridiculously complex, he feels. But if plan sponsors reframe these distribution options in a consumer-friendly way, most people have an easier time making a choice that is right for their situation.

A good question to ask is, “What does this mean to you in terms of creating an income stream?”

Participants need to think about what their assets mean in terms of creating an income stream, and what they will be able to afford. The choices need to be simple and consumer-oriented.

Goldsmith believes behavioral economics, a close cousin of behavioral finance, is a critical discipline to understanding and communicating with retirement plan participants and improving retirement readiness.

Behavioral economics focuses on consumer decisions while behavioral finance focuses on investor behaviors, Goldsmith explains. “Retirement plan participants are both consumers and investors,” he says. “Plan sponsors ought to research both fields of study to develop helpful applications for their plans.

Repeating the same timeworn messaging is not likely to reach participants. Effective campaigns that improve retirement readiness recognize that not all participants are alike, in either their goals or their expertise or their life stage.

More about behavioral economics is on Sibson’s website.