Ananish Chaudhuri: Automatic enrolment has big impact

Starting automatic enrolment in KiwiSaver would be a move in the right direction. It will increase enrolments and more people will end up with better provisioning for their retirement. Currently those who wish to join KiwiSaver have to opt in. The change the Government is proposing will enrol everyone by default with individuals being free to opt out.

On the face of it this seems trivial. After all rational adults should be able to make their own decision whether to join. But recent research in behavioural economics shows that people are often less rational than we assume them to be. They also often suffer from problems of self-control, suggesting that at least some of the low-saving households are making a mistake and would benefit from some help in getting them to save.

A number of countries including Denmark, Australia, Holland, Sweden, Switzerland and Canada have already switched to automatic enrolment and studies suggest that this minimal change has significant impact on enrolments and consequently people's saving behaviour.

This idea that changing the default option can make a big difference was first popularised by University of Chicago professors Richard Thaler and Cass Sunstein in their best-selling book Nudge. Following on from Thaler and Sunstein, a recent research report issued by the National Bureau of Economic Research in the US finds that under automatic enrolment workers join defined contributions plans at a faster rate. In one firm that switched opting in to opting out, participation rate was 35 percentage points higher after three months on the job and remained 25 points higher after two years.

When the authors of the report look at the decision of how much to contribute, they find that in one firm with a default contribution rate of 3 per cent of salary, more than one-quarter of workers contributed exactly that amount to the plan, even though the employer matched contributions dollar for dollar up to 6 per cent of salary. Once the firm switched to a 6 per cent default, workers started contributing the same proportion.

A 2013 report in the Guardian found that approximately one year after Britain introduced automatic enrolment with an opt-out feature, there were 1.6 million more savers in workplace pensions. Only 9 per cent chose to opt out.

Indeed the fact that people often fail to save enough for retirement has motivated Thaler and co-author Shlomo Benartzi to propose the Save More Tomorrow (SMT) plan. Under this plan people commit in advance to allocate a portion of their future salary increases towards retirement savings. They find that 78 per cent of the people offered the SMT plan elected to use it and a vast majority (80 per cent) remained enrolled through the next three pay raises. The average saving rates for SMT plan participants increased from 3.5 per cent to 11.6 per cent over the course of 28 months.

Making a difference by changing the default is not confined to savings behaviour alone. The strategy can be applied to other problems like the shortage of donated organs. Many countries including New Zealand have opt-out organ donor programmes, where everyone is presumed to be a donor unless they choose to opt out. These countries with automatic enrolments have donation rates that average 25 to 30 per cent higher than comparable countries with opt-in programmes.

Finally, the Government is also proposing to ditch the $1000 kick-start which was originally designed to provide an incentive for people to join. However, the move to automatic enrolment makes the $1000 kick-start less critical and will save money.

A recent study using data from Denmark compares the relative effectiveness of switching from opt in to opt out as opposed to a similar subsidy offered in Denmark. The authors of this study attribute only 1 per cent of the saving done in the Danish plans to the tax breaks while the rest of it comes from the switch to automatic enrolment.

The authors argue that subsidies may not be the most effective policy to increase retirement savings. Automatic enrolment or default policies that nudge individuals to save more could have larger impacts on national saving at lower social cost.

Ananish Chaudhuri is professor and head of the Department of Economics at the University of Auckland Business School. The views expressed are his own.
KiwiSaver Q&A
Starting this week the regular KiwiSaver Q&A column by Helen Twose will move to the Herald on Sunday. To have your KiwiSaver questions answered by the Herald's panel of industry players email Helen Twose, helen@helentwose.co.nz.