Australian School of Business
Navigating the Retirement Risk Zone: A
Consumer Perspective
December 2013
Hazel Bateman
School of Risk and Actuarial Studies
How well do consumers navigate the Retirement
Risk Zone?
Context
Individuals face increased risks and responsibilities for
retirement saving, investment and decumulation
decisions
 Participation
 Superannuation fund/Pension provider
 Contribution rate
 Asset allocation
 Retirement date
 Retirement benefit type
 Financial advice/advisor
What do Australians do?
 Participation decision: MANDATORY (for employees, 90-95%
coverage)
 Superannuation fund: < 3% (?) choose super fund (remainder
DEFAULT fund).
 Contribution rate: around 2/3 contribute no more than
minimum superannuation guarantee (ABS, 2009) (remainder
DEFAULT at min SG, 9.25%).
 Asset allocation: Around 43% assets in DEFAULT investment
option, about 2/3 industry fund assets in DEFAULT option (? 60%
members ?).
 Retirement date: Choice  NO DEFAULT
 Benefit choice: NO product DEFAULT. About 50% (assets) lump
sum/50% (assets) account-based pension, several hundred life
4
annuities sold annually.
What do Australians do?
 Participation decision: MANDATORY (for employees, 90-95%
coverage)
 Superannuation fund: < 3% (?) choose super fund (remainder
DEFAULT fund).
 Contribution rate: around 2/3 contribute no more than
minimum superannuation guarantee (ABS, 2009) (remainder
DEFAULT at min SG, 9.25%).
 Asset allocation: Around 43% assets in DEFAULT investment
option, about 2/3 industry fund assets in DEFAULT option (? 60%
members ?).
 Retirement date: Choice  NO DEFAULT
 Benefit choice: NO product DEFAULT. About 50% (assets) lump
sum/50% (assets) account-based pension, several hundred life
5
annuities sold annually.
What do Australians do?
 Participation decision: MANDATORY (for employees, 90-95%
coverage)
 Superannuation fund: < 3% (?) choose super fund (remainder
DEFAULT fund).
 Contribution rate: around 2/3 contribute no more than
minimum superannuation guarantee (ABS, 2009) (remainder
DEFAULT at min SG, 9.25%).
 Asset allocation: Around 43% assets in DEFAULT investment
option, about 2/3 industry fund assets in DEFAULT option (? 60%
members ?).
 Retirement date: Choice  NO DEFAULT
 Benefit choice: NO product DEFAULT. About 50% (assets) lump
sum/50% (assets) account-based pension, several hundred life
6
annuities sold annually.
For consumers in the retirement risk zone,
retirement benefit/decumulation decisions
are difficult
 Involve complex financial products
 Interaction with publicly provided benefits
 Cannot navigate by ‘default’
 High stakes (largest non-housing asset)
 Once in a lifetime decision no opportunity to learn
from experience (decision made once and generally
irreversible)
 Mass market DC is new  little opportunity for social
learning (ie, to learn from older generations)
7
We should not be surprised – this is what
Behavioural Economists have been telling us…
• Bounded rationality – certain types of problem are too
complex for individuals to solve on their own
• Bounded self control – individuals lack the willpower to
execute their plans
• Bounded self interest – while individuals do seek to
maximize their personal utility, they are more cooperative and altruistic than predicted by economic
theory
• Swayed by behavioural factors – loss aversion , inertia,
procrastination, framing, confusion, status quo bias,
heuristics
(Thaler and Mullainathan, 2000)
Lessons from the academic literature?
5 year ARC Discovery Grant (2010-2014): The Paradox of
Choice: Unravelling Complex Superannuation Decisions
Hazel Bateman (Risk and Actuarial, UNSW)
Christine Eckert (Marketing, CenSoC, UTS)
Fedor Iskhakov (CEPAR, UNSW)
Jordan Louviere (CenSoC, UTS)
Stephen Satchell (Cambridge UK)
Susan Thorp (Finance, UTS)
+ Julie Agnew (Finance and Economics, College of William
and Mary, USA)
Investigated the ability of ordinary people to make complex
retirement savings/investment/decumulation decisions
.
EVIDENCE OF INCOMPLETE AND
UNREALISTIC PLANS RETIREMENT
PLANNING
Survey of financial knowledge, plans and values
• Fielded in May 2011
• Online panel provided by Pureprofile
– 920 people
– Ages 50-74
– Even genders
– 60% had some post-school education
– 37% already retired
Uneven planning and expectations
 Around 30% still employed had not thought about
the financial aspects of their retirement and a
further 20% had just started to think about it
 Only around 45% of those 50+ had tried to work out
how much money they would need for retirement
(2012 Financial Literacy survey)
Uneven planning and expectations
 Optimistic lifestyle expectations of pre retirees
(travel/leisure) vs post retirees (carers/return to
work)
 Fewer than one in five discussed retirement with
friends and co-workers
 Fewer than one in four had attended a retirement
seminar
Estate planning is more common than
financial or workplace planning
 60% of surveyed had made a will
 70% had thought about leaving a financial or
material bequest
Pessimism about length of retirement
 Typical respondent was
– Pessimistic about near-term survival (75-85)
– Optimistic about survival at older ages (90 onwards)
 Men in their 50s
– Underestimated lifetime by 6 years on average
 Men in their 60s
– Close to improved life table expectations
 Women in their 50s
– Underestimated lifetime by 7 years on average
 Women in their 60s
– Underestimated lifetime by 5 years on average
.
EVIDENCE OF POOR FINANCIAL
LITERACY, SYSTEM AND PRODUCT
KNOWLEDGE
Measuring financial literacy in Australia
 Survey fielded in June 2012 – Australian extension to
Financial Literacy around the World (FLaT) study
 Online survey using PureProfile Web Panel (600,000+
Australians)
 1,024 respondents
 Nationally representative sample
 Age ranges from 18 to 84
 742 respondents aged 25-65 and non-retired
17
3 Key Financial Literacy Questions
(1) Interest rates: Suppose you had $100 in a savings account and the
interest rate was 2% per year. After 5 years, how much do you think you
would have in the account if you left the money to grow?
– More than $102 -Do not know
– Exactly $102
-Refuse to answer
– Less than $102
(2) Inflation: Imagine that the interest rate on your savings account was 1%
per year and inflation was 2% per year. After 1 year, how much would you
be able to buy with the money in this account?
– More than today
– Exactly the same
– Less than today
-Do not know
-Refuse to answer
(3) Diversification: Buying shares in a single company usually provides a
safer return than buying units in a managed share fund.
– True
– False
-Do not know
-Refuse to answer
18
Only 42% respondents answered 3 key questions
correctly
Percent Answer All Questions Correctly
Germany
Netherlands
Australia
US
Japan
Italy
New Zealand
Sweden
Russia
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
19
The same survey indicated somewhat poor
super knowledge
What is the mandatory employer contribution
under the SG
Does superannuation receive tax concessions?
If you have any superannuation you will not
receive an Age Pension
% incorrect/
do not know
33%
38%
29%
Do you know the minimum age at which you can 48%
access your superannuation account?
Only 14% of those who said
‘yes’ were correct
Of concern: If your superannuation account is
invested in a ‘balanced’ investment option, this means
that it is invested exclusively in safe assets such as
. savings accounts, cash management accounts and
term deposits
45%
40%
40%
32%
35%
30%
28%
25%
20%
15%
10%
5%
0%
TRUE
FALSE
DO NOT KNOW
A related study revealed mixed awareness of
products to provide income in retirement
Have you heard of this product?
Yes
Term deposit
Unit trust
98%
45%
Bonds
Cash management trust
Shares
67%
63%
88%
Reverse mortgage
Retirement savings account
59%
54%
Lifetime annuity
Allocated/account based pension
37%
48%
Survey of 920 superannuation fund members, 50-75 years old, May 2012
In particular, retirement income products are
not well understood
Lifetime annuity
Yes
Have you heard of this product?
- Offers lifetime income?
- Offers guaranteed income level?
37%
22%
8%
Allocated (account-based) Pension
Have you heard of this product?
- Offers choice of income subject to regulated
minimum?
- Withdrawal of capital is possible?
48%
25%
20%
Survey of 920 superannuation fund members, 50-75 years old, May 2012.
.
CONSUMERS ARE SWAYED BY
BEHAVIOURAL FACTORS
Consumers making retirement benefit decisions
likely influenced by







Mental accounting (narrow framing)
Loss aversion (eg, focus on impact of dying young)
Misleading heuristics (insurance is for bad events)
Illusion of control (wealth vs income)
Hyperbolic discounting
Framing (consumption vs investment frame)
Complexity
=> Use defaults or other decision rules
FRAMING: Brown et al (2008) Why don’t people insure
late life consumption? American Economic Review
Life annuity of $650
per month OR
Consumption frame
(spend, payment)
(% prefer life annuity)
Investment frame
(account, earn, invest)
(% prefer life annuity)
Savings account bearing
4% pa interest
72%
21%
Term annuity for 20
years paying $650 per
month
77%
48%
Term annuity for 35
years paying $500 per
month
76%
40%
Console bond paying
$400 forever
71%
27%
Benefits calculated to be actuarially equivalent.
Weak bequest motive
26
FRAMING: Brown et al (2008) Why don’t people insure
late life consumption? American Economic Review
Life annuity of $650
per month OR
Consumption frame
(spend, payment)
(% prefer life annuity)
Investment frame
(account, earn, invest)
(% prefer life annuity)
Savings account bearing
4% pa interest
72%
21%
Term annuity for 20
years paying $650 per
month
77%
48%
Term annuity for 35
years paying $500 per
month
76%
40%
Console bond paying
$400 forever
71%
27%
Benefits calculated to be actuarially equivalent.
Weak bequest motive
27
FRAMING: Brown et al (2008) Why don’t people insure
late life consumption? American Economic Review
Life annuity of $650
per month OR
Consumption frame
(spend, payment)
(% prefer life annuity)
Investment frame
(account, earn, invest)
(% prefer life annuity)
Savings account bearing
4% pa interest
72%
21%
Term annuity for 20
years paying $650 per
month
77%
48%
Term annuity for 35
years paying $500 per
month
76%
40%
Console bond paying
$400 forever
71%
27%
Benefits calculated to be actuarially equivalent.
Weak bequest motive
28
Discrete choice experiment of retirement
benefit decisions
• September 2011 (repeated Sept 2012)
• Initial - online web panel of 854 participants with a
superannuation account (ages 50-64, not retired)
Survey instrument included:
• TASK: Hypothetical allocation of ‘retirement
accumulation’ between life annuity and investment
account
• Longevity expectations, health expectations
• Product knowledge/Financial literacy
• Demographics/personal information.
Income stream choice task
Annuity, guarantee
Investment account, flexibility,
risk of account depletion,
4 levels of risk of running out of funds
Two-stage model of decision making: first
understand the products then make the choices
1. Who is involved? Test for who recalls the features of
the products correctly:
• People who understand the decision
• People who are paying attention in ‘real time’
2. Who is risk aware? Test for who chooses to reduce
the chance of low income as the risk (of running out
of funds) rises
Who understand the products and is ‘involved’
with the decision?
Numeracy
+
Basic financial literacy
+
Sophisticated financial literacy
+
Knowledge of existing retirement income product attributes
+
Subjective understanding of finance
-
Planning of financial aspects of retirement (Higher = more advanced
planning)
+
Quality of Life (Higher= better quality of life)
-
Subjective survival expectations (Higher = more optimistic)
+
Gender (female = 0, male = 1)
F
Wealth sector ($50K, $125K, $250K, $1000K)
-
Intention to retire before age 65
+
Risk-aware choices depend on understanding the
products and ‘real time’ interest.
Dependent variable (irrational) = 1 if subject decreased annuity
% when risk increased or did not move the slider at all
Numeracy
+
Basic financial literacy
Sophisticated financial literacy
Knowledge of existing retirement income product attributes
Subjective understanding of finance
Planning of financial aspects of retirement (Higher = more advanced planning)
Quality of Life (Higher= better quality of life)
Subjective survival expectations (Higher = more optimistic)
Gender (female = 0, male = 1)
Wealth sector ($50K, $125K, $250K, $1000K)
Intention to retire before age 65
Involvement score
+
Benefit choices experiment: conclusions
 People with higher financial capability pay more attention
(more ‘involved’)
 More numerate and more attentive people are better risk
managers
 Detailed understanding of specific products is critical to
risk-perception
Repeat experiment identified use of heuristics (decision
rules)
 diversification (1/n) heuristic (50/50 allocation)
 default (stay with initial allocation)
 Extremes (100% annuity, 0% annuity)
34
What have we learnt about navigating the
retirement risk zone?
 Incomplete plans, unrealistic expectations
 Poor financial skills, system/product knowledge
 Numeracy, financial competence and system/product
knowledge enhances interest/involvement
 ‘Involvement’ and numerical ability facilitates risk
awareness (and better decisions)
 Role of decision heuristics (1/n diversification, defaults)
35
Navigating the retirement risk zone – is this
the consumer perspective???
Thank you
Relevant papers
Papers
1. Economic rationality, risk presentation and retirement portfolio choice
(CenSoc and UNSW Working Paper)
2. Financial competence, risk presentation and retirement portfolio
preferences (Journal of Pension Economics and Finance, forthcoming).
3. Financial competence and expectations formation: evidence from
Australia (Economic Record 2012).
4. Superannuation knowledge and plan behaviour JASSA, 2013.
5. Work, money, lifestyle: Plans of Australian retirees JASSA, 2013.
6. Financial literacy and retirement planning in Australia (Numeracy, 2013).
7. Involvement: A partial solution to the annuity puzzle (CenSoC and UNSW
Working Paper)