Opt-in and Opt-out Pension Design

The way in which a question is asked has a strong impact on the answer given or decision made. Consider the case of opting-in versus opting-out. To consent to be an organ donor in the U.S., you must sign a paper when getting your driver's license. This is an opt-in decision chosen by only about a quarter of the drivers. The levels are even lower for countries like Germany and the U.K. On the other hand, the program can be designed in which every driver is automatically defaulted to be a donor. People not wishing to be an organ donor sign a paper opting-out. The participation rate of organ donor consent in opt-out countries (like, Austria, France, and Sweden) is typically in the high ninety percent range. The simple decision frame of having people opt-out instead of opt-in dramatically raises the participation rate.

Should contributions to defined contribution pension plans be defaulted for new employees as opt-in or op-out? They have traditionally been opt-in and this has resulted in only about one third of employees contributing.

The status quo bias causes employees to procrastinate in making their retirement plan decisions. Indeed, many procrastinate so long that they never participate in the plan. Instead of requiring the new employee to take action to enroll, enroll the employee automatically and require the person to take action to disenroll. Instead of exerting an effort to start the participation, employees participate automatically. An automatic enrollment policy in a 401(k) savings plan results in substantially more employees participating in the pension plan-a jump from one-third to nearly 90%. Although, most just stay at the default level of contribution and asset allocation. One problem with this approach is that some of the employees would have participated without the automatic enrollment. In addition, they would have contributed a higher amount and chosen a more aggressive asset allocation than the default money market fund, but they do not change the default allocation because of the status quo bias. Therefore, this automatic enrollment of employees helps many but might harm some. To overcome some of this problem, plans are now allowed to automatically enroll new employees into Life Cycle or Target Date type funds.

For other programs that use psychology to help people make better decisions, see my post.

Reference: Eric J. Johnson, and Daniel Goldstein, "Do Defaults Save Lives?" Science (2003): 1338-1339, and Brigitte Madrian and Dennis Shea, "The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior," Quarterly Journal of Economics 116(2001): 1149-1187.