The Auto-Enrolment ‘Nudge’

A discussion about the desirability of nudging techniques became very heated at a recent investor seminar on behavioural finance. Policymakers ‘nudge’ when they encourage people to make particular choices by employing techniques drawn from behavioural psychology. For instance, changing the default status in the company pension scheme for new employees from out-unless-opted-in to in-unless-opted-out tends to increase the participation rate. Indeed, this was precisely the issue that stirred delegates’ emotions.

The reason why the shift in the default status has such a profound effect is because of loss-aversion – the disproportional distaste we humans have for losses. For most people, a loss is perceived with more than twice the intensity as a gain of an equal amount. This means that simply act of swapping one thing for another of equal value represents a negative outcome, because we perceive the loss of the thing we surrender more heavily than the gain of the thing we receive. The consequence is that we do not like change too much and tend to stick with the default. In the case of a prospective new entrant to a pension scheme, the idea of sacrificing current consumption in exchange for increased consumption in retirement is not too appealing. However, if the default is that people are automatically enrolled in the scheme, the perception is different:  the choice is to lose consumption in retirement in order consume more in the present.

The appeal of nudging for policymakers is obvious: they advance their policy objectives, at least at the margin, without incurring any significant costs or taking any responsibility for the outcomes. Critics, including some of those in the seminar audience dismiss the technique as a paternalistic psycho-trick that is not necessarily in the interest of each individual.

The psycho-trick claim is undeniable, although one should not forget that a default already existed before the nudgers came along. Choices are almost always presented in a frame: will a new margarine be advertised as containing 50% fat or as 50% fat-free? Sometimes these frames are deliberate, sometimes accidental. But who says that the pre-existing frame is the best one for any individual? When one considers the extent to which people under-save for their retirements, one could argue that the old frame has not served the population too well. For single individual, though, as one delegate suggested, the nudge could be sub-optimal. Take the example of people who have expensive credit card debt. To put money into a pension scheme instead of paying down the debt would have negative implications for their overall wealth. This is true. However, people with no pension and maxed-out credit cards almost certainly have other behavioural problems related to self-control. Reaching the credit limit on their plastic might be the only thing that is preventing them from accumulating even more expensive debt. To forego a pension in order to reduce the debt could mean that they reach retirement with the same level of indebtedness, but no pension.

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