Over the next 5 years, nearly 3.5 million people in the UK will be making decisions about their retirement income. Despite worthy attempts by the regulator and industry to inform the process, the majority of people will sleepwalk into a purchase. Promotion of the open market option (OMO) and education about the growing range of options at retirement have enjoyed some success, but the majority of people are still expected to end up with a traditional annuity.
With annuity rates at historic lows and inflation eating into income, it’s critical that people make good money decisions when they retire. But why are people still making sub-optimal choices and what can we do to improve the process?
At an annuities conference run by Westminster and City last week, Linstock Associate Professor John Maule outlined some of the latest insights from behavioural economics to explain why these at-retirement decisions are often sub-optimal. Picking up on key themes first included in a research report for MGM Advantage and the Prudential released earlier this year, Professor Maule described how a limited appetite and capacity for complex thinking means people rely heavily on shortcuts in thinking to make decisions (providing more information only increases the tendency of people to use these shortcuts):
• One example is satisficing, where people select the first option that is reasonable, rather than considering the merits of all the available options and then choosing the best.
• Most people are predisposed to the status quo, sticking with what they are used to or doing what everyone else does rather than working out what is actually best for them.
• The way information is given to people can crucially affect their appetite for risk. Outlining the investment profile in terms of gains makes people risk averse. Presenting the same information in terms of potential losses increases appetite for risk. Most providers are unaware of this effect and do not tailor their communications to consumers appropriately.
Armed with an understanding of how people think, financial advisers can counsel their clients more effectively. But with new Association of British Insurers (ABI) figures showing the percentage of non-advised annuity sales increasing year on year, it is critical that customer facing material (be that brochures, videos or website) is attuned to the latest thinking. In terms of the three factors described above, this could mean:
• Giving careful consideration to the order in which product options are provided.
• Highlighting the growing numbers of people who are looking at a range of alternative products and providers, encouraging key influencers like the money press to follow suit, using a range of typical case studies to show that the ‘norm’ is changing.
• Framing discussions about retirement income in terms of potential losses, not necessarily to encourage risk taking, but to encourage consideration of the full range of options.
More research is needed, but applying the latest theory from behavioural economics is already helping the huge wave of baby boomers approaching retirement make better decisions. For example, psychologists in the health sector are doing some very effective work with online decision tools.
A copy of our report for Prudential and MGM Advantage is available on our website.