Issue: March 2012 / May 2012
Expert Opinion

Architecture of choice

Kobus Hanekom, executive consultant at Simeka Consultants & Actuaries, proposes a practical method for trustees to assist fund members make better decisions.

Hanekom . . . default option

Hanekom . . . default option

A key feature of the typical defi ned-contribution retirement fund is the levels of member choice. The question is whether it’s serving us well.

Results of member surveys suggest not. These typically refl ect that members are apathetic and lack understanding, but are often disinterested in learning more and suffer from inertia. There’s a fear of making decisions.

When members do act, the surveys indicate, they suffer from short-term thinking (what the Americans call “reckless conservatism”). Studies fi nd that, when members do make decisions, they often destroy rather than create value. This is discouraging news for those of us who are passionate about the benefi t structures we design and implement.

It’s not just a South African problem. At an International Pension Lawyers Conference early last year, the consensus was that most jurisdictions are not short of legislation and industry standards, and service providers also do not seem to be too bad at implementing them. The problem lies in getting the members to pay attention and take action.

Behavioural economics

From this perspective, member behaviour is perhaps more understandable. Firstly, retirement fund membership is effectively compulsory. Secondly, members’ needs are determined by their levels of income i.e. those with lower incomes focus on food and shelter while those with higher incomes focus on the education of their children and then a home.

Only when they have satisfi ed all other basic needs do they consider and spend money on retirement provision. So it is not strange that members do not have an emotional connection with their fund. They probably feel that “since it is forced on me, I need only pay attention when there is a benefi t event”. Seen from this angle, it is not particularly wise for funds to respond by complaining and trying to change member behaviour. Member education remains important and must be pursued. However, in the shorter term a more compelling solution would be to accept member apathy as a business reality and accordingly to adjust not only communication strategies but also benefi t structures.

Why offer choice in the fi rst place?

The reason is that benefi t structures are designed to suit the majority of members. Members who are richer or older or sicker have different needs than others, and it is only fair that they be allowed a choice.

But there is a right and a wrong way of introducing choice. Instead of offering a member a selection of 20 investment portfolios and saying tick a box, the better approach is to say “This ‘default portfolio’ has been selected for you by the trustees and should serve your needs for the following reasons. If your needs are different, complete this form in which you state that and take full responsibility for the choices you wish to make.” In this way, we use the architecture-of-choice principle to prepare a glide path in which we stack the odds to favour members.

All choices should be accompanied by default solutions for withdrawal and retirement. This is the one instance where the retirement fund industry has let its members down.

Members who are about to retire typically have no experience or training to equip them to correctly decide on an annuity strategy. Should the member go for a guaranteed annuity or a fl exible annuity? Which product should they choose? Which of the fi nancial advisors that clamour for their attention should they select? And even if the member gets all of that right, the transaction will be at a retail cost structure.

It is far easier for the trustees to use their considerable negotiating power to develop appropriate solutions, not at retail cost but at a wholesale cost (with seamless transfers etc). With such a glide path in place, a fund would be more than halfway towards its goal of guiding members to an appropriate result.