Know your plan member

Mercer’s latest Retirement Perspective report focuses on the first stage of a typical DC member’s participation in a plan, in which he or she joins up. Possibly the most difficult phase, it requires members to make many decisions at once and can lead to procrastination or avoidance of the issue. Automatic enrollment has helped to counter this phenomenon and is increasingly being adopted.

Mercer identifies six elements that affect members’ decision-making capabilities and suggests solutions for each.

Overconfidence – Many plan members simply assume they’ll be earning more in the future and will be able to delay contributions without a noticeable difference on retirement income. Mercer suggests that clearer education on the tax advantages and other “free” money available from pensions, such as the plan sponsor’s contribution, is needed.

Procrastination – Too many decisions can overwhelm plan members and result in no action at all. Limiting the decisions they need to make or framing the decisions in a more logical way can help improve take-up, as does implementing auto-enrollment.

Myopic loss aversion – People place a far greater value on the short-term value of cash than on possible long-term returns. In order to counter this, plan sponsors could try promoting additional benefits of tax and employer contributions in absolute terms as a way to encourage members to join a plan. Simply reducing the initial contribution or making a plan non-contributory will also increase the take-up.

Inertia – Members who don’t join a plan when first offered the opportunity are unlikely to join in the future, despite their best intentions. The key is to help them make a provisional decision at the time of the offering. Similarly, members are unlikely to change a decision unless prompted through communication or other means. Plan sponsors can keep members engaged by reminding them of their original decision and telling them that it will be executed, unless they wish to opt out.

Choice overload – The number of investment funds and the way they are offered to members can affect if and how they invest. Too much choice can be a disincentive for members to choose their own funds, and many opt for the default or do not join the plan at all. An initial offering of less than six or seven funds, with a more extensive layer of advanced funds, has been shown to encourage choice. Also, simplifying the name of the fund and removing the name of the manager has also been shown to improve fund choice.

Optimal asset allocation –Members are not financial professionals and should be able to count on the assistance of trustees and plan sponsors that are in a better position to offer optimal diversified strategies that are most appropriate to employees’ needs.

What plan sponsors can do:
Auto-enrollment—where possible—is the easiest route. Where participation is voluntary and auto-enrollment is possible, using auto-enrollment will encourage plan participation, particularly if the DC plan is the only one offered. Failing that, Mercer suggests the following steps:
• Limit the number of decisions that employees need to make.
• Make contributions affordable for the lower-paid employees.
• Set the contribution for auto-enrollment at a higher-than-normal rate. Plan members are more likely to retain the contribution rate at the level they were enrolled at indefinitely, so including automatic-increase options is best introduced at the outset.
• Ensure that default investment options are consistent with the plan’s design and objectives.
• In work environments without auto-enrollment, regularly encourage employees to enroll in the plan.
• Trustees can tailor a limited range of optimal investment options to members with limited understanding of, or interest in, investment matters.
• Offer an extended range of funds for members who want more choice.
• Employ progressive, life-stage-linked communication strategies.

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