Spend More Today Safely: Using Behavioral Economics to Improve Retirement Expenditure Decisions With SPEEDOMETER Plans

• Date: 01 March 2014
• Author: Tom Boardman,David Blake
• DOI: http://doi.org/10.1111/rmir.12007
• Published date: 01 March 2014

Risk Management and Insurance Review

C

Risk Management and Insurance Review, 2013, Vol.17, No. 1, 83-112

DOI: 10.1111/rmir.12007

PERSPECTIVES

SPEND MORE TODAY SAFELY:USING BEHAVIORAL

ECONOMICS TO IMPROVE RETIREMENT EXPENDITURE

DECISIONS WITH

S

PEED

O

ME

T

E

R

PLANS

David Blake

Tom Boardman

ABSTRACT

This article examines how behavioral economics can be used to improve the

spending decisions of retirees, using a SPEEDOMETER(or Spending Optimally

Throughout Retirement) retirement expenditure plan that employs defaults

within a choice architecture. The plan involves just four key behavioral nudges:

(1) first, make a plan—ideally by being auto-enrolled into one or with the help

of a financial adviser; (2) automatic phasing of annuitization, which is designed

to tackle the aversion to large irreversible transactions and losing control of

assets, and so allows the greatest possible degree of flexibility in managing the

rundown of retirementassets; (3) capital protection in the form of “money-back”

annuities that deals with loss aversion, that is, the fear of losing your money

if you die early; and (4) the slogan “spend more today safely” that utilizes

hyperbolic discounting to satisfy the human trait of wanting jam today, and to

reinforce the idea that “buying an annuity is a smart thing to do.”

INTRODUCTION

In 2004, Benartzi and Thaler (2004) came up with the brilliantly simple idea of SAVE

MORE TOMORROW (SMART) plans that exploit behavioral traits such as inertia, hy-

perbolic discounting,1and money illusion to increase retirement savings using auto-

matic deferred salary sacrifice.2The concept worked and has been implemented, with

certain modifications, in a number of countries. For example, in the United Kingdom,

a new national pension plan called NEST (the National Employment Savings Trust)

was introduced in 2012 (Pensions Acts 2007 and 2008). This will use auto-enrollment

David Blake and Tom Boardman are with Pensions Institute, Cass Business School, 106

Bunhill Row, London, EC1R 1XW, United Kingdom. David Blake can be reached by e-mail

at d.blake@city.ac.uk. Thisarticle was subject to double-blind peer review.

1This means that individuals use higher discount rates for more distant cash flows than they

do for nearer cash flows, with the consequence that distant cash flows are relatively much less

highly valued today than nearby cash flows.

2This is where a portion of future pay rises is diverted to the employee’s pension plan.

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to increase retirement savings. Younger employees can therefore overcome a potential

problem facing many of their older colleagues, namely, insufficient pension savings

leading to poverty in old age, a phenomenon that is inconsistent with the predictions of

the Life Cycle Model (LCM).3

Behavioral economists have identified some of the limitations of conventional economic

theory caused by the failure to take human behavior into account. Richard Thaler and

Cass Sunstein in their best selling 2008 book Nudge: Improving Decisions About Health,

Wealth and Happiness define two very different types of consumers—“econs” and “hu-

mans.” In a retirement expenditure context, “econs” are fully rational life-cycle financial

planners. “Humans,” by contrast, try to make the best decisions for themselves, but are

subject to behavioral traits that limit their ability to implement their plans. Thaler and

Sunstein believe that very few people are “econs” and their book provides examples of

how to nudge “humans” into making optimal choices.

In simple terms, the aim of this article is to look at how “econs” would optimize their

financial plans in retirement, and then to find ways to nudge “human” retirees into

making optimal choices. Is there something akin to SMARTplans to help retirees spend

the money that they have saved during their working lives by being optimally “smart”

through retirement?

As the Baby Boomers begin to retire, a different set of behavioral issues confront them,

and reluctance to save is replaced by a reluctance to annuitize and the possible subopti-

mal drawdown of retirement assets. This article examines ways in which behavioral eco-

nomics can be used to overcome the so-called “annuity puzzle,” the reluctance of retirees

to voluntarily annuitize sufficient of their assets to adequately hedge their longevity

risk. We do this by introducing SPEEDOMETER(or Spending Optimally Throughout

Retirement) retirement expenditure plans. We use the term SPEEDOMETERto reflect

the fact that spending optimally is related to the speed with which assets are drawn

down, and a SPEEDOMETERis a useful device both for measuring and influencing

speed.

ASPEEDOMETERretirement expenditure plan helps retirees pace their spending

throughout retirement in order to optimize their lifetime income to cope with retire-

ment income shocks and their ability to make intended bequests by: (1) first, making

a plan, either by being auto-enrolled into one as part of the retirement planning ser-

vice offered by the plan member’s company, or by using an online or telephone-based

service providing generic financial advice, or, if wealth permits, involving a financial

adviser whose role is to assist with making and implementing the plan, and conducting

3The LCM, introduced by Ando and Modigliani (1963), is still the dominant model used by

conventional economists. In the LCM, individuals are assumed to have the skills to allocate

their lifetime income and assets over their life cycle in order to maximize the expected lifetime

utility of the consumption stream that can be purchased with the income and assets, taking

account of attitude to risk. In the absence of a bequest motive, accumulated savings are run

down to zero at the time of death: individuals die clutching their last penny and never run out

of money while still alive.