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Defeating Egocentric Bias – Meeting Workers Where They Are (Second of Two Articles)

09/12/2018
By Jack Towarnicky

In a prior blog, I noted that Laraine McKinnon, LMC17, presented at our Plan Sponsor Council of America National Conference about her book Known: How to Create a Great 401(k).  My prior post focused on plan management and plan design. This time, I wanted to share Laraine’s insights into behavioral economics concepts, and to specifically discuss egocentric bias.  

Behavioral Economics Concepts Affecting Participants

Laraine focuses on various biases that affect participants, such as: 

  • Inertia: Participants who aren’t saving at all are unlikely to start saving on their own; a participant who is saving at 3% is likely to keep saving at 3%; a participant defaulted into a fund is likely to remain in that fund; a participant who selects a specific allocation when joining the plan is likely to remain in those allocations; and a participant who intends to save more tomorrow is likely to keep deferring to tomorrow. 
  • Loss aversion: Some studies show that people feel losses twice as much as they appreciate gains. 

She highlights a number of studies by economists that show: 

  • Employees often take the path of least resistance.
  • Defaults are not neutral- they can either hinder or facilitate savings outcomes. For example, a voluntary enrollment system has a default of no participation unless the individual enrolls and has a default savings rate of zero.
  • Many employees perceive defaults as a recommendation or endorsement from their employer.
  • The vast majority of participants will accept the automatic enrollment defaults (default savings rate, default investments, default increases/escalation, default asset retention, etc.).
  • In terms of participation rates and deferral rates, auto-enrollment and auto-escalation easily outpace those achieved in voluntary plan enrollment where new hire participation rates are often less than 50%.
  • Many employees know they are not saving enough and plan to increase contributions in the future, but many fail to take action
  • Choice blindness impacts participation and participation rates fall as complexity increases.
  • Participants do not understand the risk of holding company stock.
  • Some older, longer-service workers who are fully vested and eligible for penalty-free withdrawals fail to contribute enough to obtain the full employer financial support.

Behavioral Economics Concepts Affecting Plan Sponsors 

In her book, Laraine highlights various organizational behavior concepts and biases that negatively impact 401(k) plan sponsors and other decision makers, such as:

  • Anchoring: Where a prior decision to automatically enroll individuals at a 3% contribution rate impedes a change to a new default rate of 6%, coupled with escalation up to 12%.
  • Belief: Where a prior decision to use actively-managed funds impedes adoption of passive or indexed funds.
  • Confirmation: Where a long-ago past decision, such as a decision to offer company stock that has achieved favorable returns and attracted significant assets, impedes changes to investment options.
  • False Consensus: Where a person or group overestimates the extent to which others will react negatively based on assumptions of what is normal. This often is encountered in discussions about the reaction to introducing automatic features.
  • Framing: Simply changing how something is presented and described is both a bias and a behavioral economics tool.  For example, framing an annuity related to spending is received more favorably than framing it as an investment with a potential loss of value upon death.
  • Hot Hand Fallacy: Past performance may not be indicative of future results.
  • Sunk Costs: The reluctance to give up on a prior investment that has not yet been effective but cannot be reclaimed. 

Overcoming Egocentric Bias

Egocentric bias occurs when a plan sponsor fails to consider situations from workers’ perspectives.  It is the tendency to rely too heavily on one's own perspective. Research has shown that experiences, ideas, and beliefs are more easily recalled when they match one's own. Egocentric bias may influence judgement to the point where people not only believe that self-interested outcomes are preferential, but are also the best way to proceed. Laraine highlights situations she has encountered where successful senior executives are called upon to make decisions about plan design to overcome inertia or loss aversion (see above) where some are not able to fathom why workers fail to take full advantage of the plan.  Many have never lived paycheck-to-paycheck or been deep in debt (or perhaps they left that financial condition long ago).   

Today, we see similar egocentric bias all around us. Many academics and public policy wonks see the 401(k) as a failure because it isn’t solely focused on retirement preparation and/or retirement income.  Consider these:

Back in 1986, I came face-to-face with my own egocentric bias. In a discussion with a brilliant marketer and communicator on our staff, she asserted, “Some people just can’t afford to save in the 401(k).”  To which I responded, “They can’t afford not to save.”  She was focused on the every-day reality many workers faced – those living payday-to-payday, those deep in debt. I was focused on the loss from foregoing the tax preferences and employer financial support.   

I took a step back to identify how we might redesign the plan so that there would be a preference for saving in the 401(k) plan for all workers and how to make that a reality. One change we pursued was adding a loan feature to our plan – rolled out less than 18 months later on July 1, 1988.  We encouraged individuals to enroll, save, and if necessary, borrow.  The focus was much more holistic, a focus on improving “household wealth,” not necessarily increasing “retirement asset accumulations.”  The strategy was to meet a diverse group of workers where they were – wherever they were financially.  

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