Inertia and Choice

The use of employer decided opt-out solutions like automatic enrollment, automatic escalation and target date funds represents an important advance for employer sponsored defined contribution plans. They have brought thousands of new participants into the 401(k) system and enhanced the savings of many more. Many credit “inertia” for the success of these approaches and “inertia” is an important factor, but there is more going on here. “Inertia” works when there is an alignment of participants’ interest with the decisions being made for them. Every automatic enrollment program I know of is accompanied by an intensive explanation to employees about the benefits of being automatically enrolled. It is a mistake to assume that participants will accept without question or objection anything that is put in an opt-out structure.  

I know this is true because we have a clear example. The default distribution option of a pension plan is an annuity. Participants who want to take a lump sum where a lump sum is available have to go through some effort to override the default. Overwhelmingly, they choose the lump sum, often in the face of significant educational efforts to discourage them from doing so. The rejection of the government mandated joint and survivor annuity solution could not be any clearer. In this case participants have determined they do not like the default, and “inertia” does not deter them.

David