VOL. 22, NO. 1
From the Editor
Nudge: What Every Benefits Lawyer
and Consultant Should Know About
Human Nature
sychology, economics, and neurology are being combined into
a highly practical new discipline focused on decision making—
specifically, why even smart people sometimes do very foolish things,
while others fail to make any choice at all. By harnessing this learning, employers can help employees make better decisions on using
their benefit options and preparing themselves for a strong financial
future, while still allowing employees the freedom to make their own
choices. The first fruit of this new “science of choice” is the highly
effective 401(k) plan auto-enrollment program design.
There is plenty of literature available that explains what we need
to know about choice and why people frequently make poor decisions. An ideal place to start is Nudge, a highly readable new book
by Richard Thaler and Cass Sunstein (Caravan books). It discusses
how each of us has logical and rational decision-making powers, as
well as more reactive, impulsive instincts—think Star Trek’s Mr. Spock
versus Homer Simpson. Instincts are great in an emergency but often
let us down when it comes to more analytical matters like saving
and investing. If asked, many employees probably would say their
personal decision making is akin to the more rational Vulcan perspective. But especially when it comes to matters related to retirement,
savings, and health and welfare plan enrollment, participants tend to
act more like mortals, complete with some hard-wired characteristics
that ultimately can lead to poor choices.
For one thing, humans tend to be unrealistically optimistic. Most
people rate themselves as having above-average abilities (which, of
From the Editor
course, is mathematically impossible) and commonly overestimate
what they can do, how fast they can do it, and why they won’t succumb to the mistakes others have made before them. At the same
time, most people are highly loss averse. Countless studies have
shown the hurt experienced after a loss is about twice as great as
the good feeling following a gain. The recent stock market is a
perfect laboratory—just think about how much more emotional you
felt on days your 401(k) account declined by 2 percent, as opposed
to the days it grew by that amount. People also have a strong herd
mentality. There’s real comfort in conforming with what everyone
else is doing, and, even if it’s the wrong choice, you’ll be in good
company. If you’ve ever been in a situation in which others were
panicking, you know how hard it is to keep your own wits about
you. Finally, and despite the constant focus on “change” in the
recent presidential election, when push comes to shove, humans
generally stick with the status quo. Inertia is a powerful force, which
helps explain why employees change their 401(k) plan investments
infrequently, if at all, and why folks tend to use the recent past to
predict the future. On that basis, if house prices have been going
up lately, they should continue rising indefinitely—unless, as it has
turned out, they don’t.
The Homer Simpson in us is most likely to overpower our inner
Mr. Spock when we face issues about which we have little experience, information, or feedback. For many employees, this precisely
describes their decision making in regard to retirement planning, saving, investing, and medical coverage. Even smart and well-educated
employees generally do not necessarily have the time or knowledge
needed to make decisions that are in their best interests. Important
benefits decisions are made infrequently—open enrollment only
comes once a year, and most people only retire once a lifetime, and
there is little feedback available to make mid-course corrections. When
you ask these overly optimistic, loss-averse, status quo-oriented, busy
workers to make complex financial decisions, it can result in some
poor choices being made.
The authors of Nudge argue that some simple changes in what
they call the “architecture of choice”—reframing how alternatives
are presented—can help employees make better savings, investment,
health, and other coverage decisions, without Big Brother’s choosing
for them. The authors point to the typical school cafeteria (which is,
after all, similar to a cafeteria plan) where the placement of various
foods—whether at eye level, at the beginning or end of the line, and
so forth—dramatically affects what ends up on students’ trays. Proper
placement can, without in any manner limiting kids’ options, make it
much more likely they will opt to take fruit and milk as opposed to
soda and Ring Dings.
VOL. 22, NO. 1, SPRING 2009
From the Editor
The same principles can be applied to adults faced with decisions
about how much of their earnings to set aside in savings, where to
invest, which health plan option to select, how much life insurance
to sign up for, and when to schedule retirement plan withdrawals.
The authors persuasively demonstrate how, as with cafeteria food
selections, even small changes in the manner benefits programs are
presented can gently “nudge” employees to make smarter choices.
To see how benefits programs can be tweaked to significantly
improve participants’ elections, take a typical 401(k) plan which
allows employees to contribute up to 60 percent of pay with a 100
percent match of the first 3 percent contributed and 50 percent of the
next 2 percent. If employees are encouraged to contribute 5 percent
of pay to get the free match, a certain percentage will get the message
and contribute 5 percent. But if the employer instead urges employees to contribute 5 percent so they don’t lose the company match, the
loss aversion instinct will kick in and many more folks will decide to
contribute 5 percent.
Of course, including an auto-enrollment feature, whether at 3 percent, 4 percent, or more, would be a powerful nudge. One issue with
auto-enrollment is that many participants view the default rate as the
optimum contribution level carrying the expert’s seal of approval.
That’s why it’s crucial to not set the default rate too low and to use
auto-escalation to nudge employees to higher savings rates.
Another technique would be informing employees (if true) that
“most of your fellow employees contribute at least 6 percent of pay.”
Herd mentality will push more employees to contribute 6 percent
or even more, given their “I’m above average” instinct. Even something as simple as reversing the order—saying, “You can contribute
as much as 60 percent or as little as 1 percent—would nudge some
participants to contribute more. The reason is that generally the first
number presented has “framed” the employee’s starting thought process at 60 percent, not 1 percent.
To create the maximum nudge, the employer could say something
like, “If you do nothing, you will automatically save 3 percent, but
you need to contribute at least 5 percent so you don’t lose the company match. But, you should know that most of our employees do
even better and save at least 6 percent of their pay.”
Another way of encouraging higher 401(k) contributions is to create
new reasons for employees to save more. Over two decades of experience with 401(k) plans has shown that for many participants, the
obvious benefits of having a more secure financial future are not sufficient to result in saving money in a retirement program. Retirement
is just too far away to compete with the immediate rewards of a new
car or even a night on the town. Gimmicks such as giving a can of cat
food to employees who aren’t saving enough so they can “get used to
VOL. 22, NO. 1, SPRING 2009
From the Editor
their retirement diet” generally may not be effective. But that choice
could be reframed to appeal to a spendthrift: “If you save an extra
2 percent of pay, you’ll have enough money to drive a nice car and
eat out more often when you’re ready to retire.” That’s the kind of
feedback a Homer Simpson needs to resist the impulse to spend
instead of save. A similar message can help discourage plan withdrawals: “If you leave that $5,000 in the plan until you’re 65 and earn
a 6 percent return, you’ll have enough money for a three-week luxury
cruise to the tropics.
Nudge shows that there is no such thing as a “neutral” design. One
option has to be listed first on the election form, and there has to
be a default option, even if it’s nonparticipation. When designing a
benefits program, the choice architect must first figure out what the
average employee would most likely choose if the logical, thinking
part of his or her brain were in control, and nudge employees in that
direction. That might include making the likely preferred choice the
default option, providing prompt feedback and incentives for sound
choices, keeping the choices simple, and finding ways to gently steer
employees in the correct direction. I recommend reading at least
enough of Nudge to understand more about the inner workings of
the human mind that, with a gentle nudge, can lead employees to
make wise choices.
David E. Morse
K & L Gates LLP
New York, NY
Reprinted from Benefits Law Journal Spring 2009, Volume 22,
Number 1, pages 1-4, with permission from Aspen Publishers, Inc.,
Wolters Kluwer Law & Business, New York, NY, 1-800-638-8437,
VOL. 22, NO. 1, SPRING 2009