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FINANCIAL SERVICES COUNCIL / DELOITTE FUTURE LEADERS AWARD 2010 What action can the superannuation industry and the Australian Government take to increase young people's engagement with their superannuation
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FINANCIAL SERVICES COUNCIL / DELOITTE FUTURE LEADERS AWARD 2010 What action can the superannuation industry and the Australian Government take to increase young people's engagement with their superannuation and take an interest in their retirement incomes? Nicole Chew Australian Securities & Investments Commission August 2010 Table of Contents Introduction... 3 Defining engagement in the context of young people and superannuation... 3 Where is the evidence that young people are not engaged?... 4 Why increasing young people's engagement with superannuation is important... 5 Benefits to young people... 5 Superannuation system and superannuation funds... 5 Australian Government... 6 Why aren't young people engaged now?... 6 Barrier 1 emotional barriers/ behavioural biases... 6 Self control or present bias... 6 Loss aversion... 7 Too many choices... 7 Inertia and Procrastination... 7 Framing and default bias... 7 Barrier 2 Life barriers... 7 Barrier 3 System and product operation... 8 Barrier 4 knowledge barriers (the concept of superannuation)... 8 Financial literacy... 9 What can the Australian Government and the superannuation industry do to increase engagement? 10 Product design and financial literacy Stage 1 The Early Years Addressing Barrier 1 Emotional barriers/behavioural biases Addressing Barrier 3 - System and product operation Stage Activation Voluntary contributions Financial Literacy Stage Increasing engagement generally Interest and identification Communications Conclusions Bibliography Introduction 1 Saving, and super and stuff is what you should do but you don't really see the benefit of it now. It's like eating healthy and that there's heaps of things you are supposed to do but who does. Other things are more important right now. (Participant, McCrindle Research Report) 2. Increasing young people's interest in superannuation is challenging and has occupied the minds of Government legislators and policy makers, superannuation funds and regulators since superannuation became compulsory. Often this work has focused on the better pitching of messages about superannuation to young people. It has also been predominantly about improving financial literacy. This paper takes this work further by developing a way of encouraging young people's engagement with superannuation through a superannuation learning account. This learning account embeds financial literacy modules into the product, with incentives to participate. It aims to overcome barriers to engagement, increase knowledge and effect permanent behavioural change. This paper starts with a definition of engagement with superannuation, as applied to young peoples' life situations and characteristics. It reviews the importance of improved engagement, for young people, the superannuation industry and the Australian Government. Barriers to engagement are then outlined, with the solution, a tailored superannuation learning account, presented as a viable way to overcome these barriers and increase young people's engagement. For the purposes of this paper, I define young people as those less than 40 years of age 3. No distinction is made for gender 4. Engagement is defined as a process, with interest, identification, motivation and behavioural change (or action) linked circular factors in this process. Defining engagement in the context of young people and superannuation Superannuation, a long term investment for a long term event (retirement), does not engage young people's interest, identification or motivation. Within this group, there are probably three divisions, loosely correlated to the generational groups of Generation X, Y and Z, but, more importantly, linked to lifecycle savings stages. The members of the under 40s age group are not homogenous so, in reviewing the characteristics of this group, it is necessary to be aware of these divisions. 1 This paper expresses my personal views and opinions, and not that of the Australian Securities & Investments Commission. 2 Mark McCrindle, 'Finances & the Under 40's: A Research report on Generation X and their views on Superannuation' (2006) http://www.mccrindle.com.au/wp_pdf/006064wpfssfinancesu40s.pdf at 27 May 2010, 7 3 This follows the definition in the House of Representatives Standing Committee on Economics, Finance and Public Administration, Parliament of Australia, Improving the Superannuation Savings of People under 40 (2006) [1.1] 4 It is acknowledged that gender is an important factor in the engagement process. Women may have lower superannuation balances and gaps in the engagement process. However, for the purposes of this discussion, I will not address this issue, as the solutions proposed to increasing engagement should apply irrespective of gender, due to the timing of the interaction with the superannuation learning account. 3 Technology is the biggest development that differentiates young people from older demographic groups. The younger members of this group have never known a world without technology, including the internet, mobile phones and social media. This influences their engagement with superannuation, as they expect information to be instantaneous and available on demand. Young people expect superannuation funds to interact with them by means (both communication channels and language) that they understand and can identify with. Therefore, applied to young people, indicators of engagement with superannuation could include: awareness of, and active interest in, superannuation, and how it will be increasingly relevant later in life; identification with, and a sense of belonging to, a particular superannuation fund, that has been actively chosen by a young person; a single superannuation account, that a young person takes with them, from job to job; confidence in regard to superannuation (feelings of competence, control and responsibility); regular monitoring of their superannuation balance; and thinking about and taking steps towards planning for retirement. Actively choosing a superannuation fund would include: an awareness of, and review of, fees and costs for the selected superannuation fund; selecting an optimal investment option (or mix of options) based on their investment horizon and risk preferences; adequate life, TPD and income protection insurance coverage, and awareness of the benefits of holding insurance within a superannuation fund. Where is the evidence that young people are not engaged? Many young people are far less engaged with their superannuation than older demographic groups, because retirement seems such a long way in the future and they do not identify with the issues. The latest Mercer Superannuation Sentiment Index (March 2010) 5 confirmed that young people were less likely than older age groups to understand or know key aspects about their superannuation 6. The research showed that 96% of year olds had not given serious thought to preparation for retirement 7. 5 Mercer, Securing Retirement Incomes: Superannuation Sentiment Index (March 2010) http://www.mercer.com.au/attachment.dyn?idcontent= &filepath=/attachments/english/mercer_au_super_sentiment_ Index_March_2010_Web.pdf at 15 July Ibid 36-37: 29% of the year subgroup did not know or were not sure of the investment strategy of their main superannuation fund. In a separate question, 29% of the year subgroup also did not know or were not sure of their superannuation balance. 7 Mercer, above n 5, 12: 28% had not given much thought to retirement and had not made any preparations, 42% had given some thought to retirement but had made very little preparation, and 26% had given some thought to retirement and had made some preparation, but not nearly enough. 4 In other research 8, 30% of people surveyed considered that the statement My employer makes the compulsory superannuation contributions but beyond that I haven't really thought about retirement planning described them well 9, while 33% thought that the statement I think about my retirement planning from time to time but am yet to take any action described them well 10. Why increasing young people's engagement with superannuation is important Benefits to young people If people are engaged with their superannuation from the beginning of their working life, they are more likely to maximise their retirement savings during the accumulation phase and are less likely to suffer from a retirement expectations gap (ie a gap between the amount of money that a person would like to have in retirement, based on a replacement rate of current income, compared to the amount that they will actually receive 11 ). The effects of compounding interest mean that small choices at the beginning of participation in the workforce can have a significant impact on the level of savings at retirement. Using the superannuation calculator on FIDO, the Australian Securities & Investments Commission's consumer website, an extra 2% annual return over 40 years results in an additional $129,000 at retirement 12. Superannuation system and superannuation funds There are significant benefits to superannuation funds if young people are more engaged. One benefit is reduced administration costs and wastage. Superannuation funds would not have to spend money administering lost accounts, which are no longer receiving contributions. Communication costs with members, through advertising, marketing, and field officers, could be better directed to promoting the fund rather than attempting to increase engagement generally. Increased engagement through consolidation of multiple low balance accounts may mean that some superannuation funds will lose some members in the short-term. However, the flip side is that once a young person is a member, they are likely to remain so for life. If young people are more engaged, leading to increased superannuation balances, revenue will increase. Increased engagement would also hopefully allow superannuation funds to better understand their members, and deliver products which better suit their members' needs. 8 Financial Services Institute of Australasia (FINSIA) Public Opinion Research Report Saving the Future, can the under-40s afford to grow old? (July 2006) 9 Ibid Ibid 11 Rice Warner Actuaries Superannuation Adequacy Prepared for IFSA (January 2010), http://www.fsc.org.au/resourcecentre/publications.aspx at 23 May 2010, This calculation assumes a starting balance of $5,000, gross annual salary of $50,000, management costs of 0.55%, management fee of $52, no contribution fee, insurance premiums of $78 per year, no adviser service fee and compares an investment earning rate before management costs & tax of 6.5% to 8.5%. Other assumptions are noted at the FIDO website at 5 Australian Government Greater engagement from young people would also reduce costs and inefficiencies in the system, thus making it more likely superannuation will deliver on the policy intent of individual self-provision for retirement. Australia has an aging population. The 2010 Intergenerational Report estimates that by 2050 ...there will only be 2.7 people of working age to support each Australian aged 65 years and older (compared to 5 working aged people per aged person today and 7.5 in 1970)... 13. This means that, without taking into account proposed measures to address this issue, the Government will face substantial fiscal pressures to provide an age pension for those eligible. Early personal engagement with superannuation should reduce age pension demand. Why aren't young people engaged now? A number of barriers prevent or deter young people from engaging with their superannuation. The categories outlined below are not mutually exclusive, and aspects of them may overlap. Barrier 1 emotional barriers/ behavioural biases Most young people recognise that saving for retirement through superannuation is important. In the FINSIA research, 79% of those surveyed agreed (and 46% strongly agreed) that 'superannuation is a good way to make me save' 14. However, a number of 'emotional' barriers mean that this knowledge does not translate into increased superannuation engagement or action among young people. This is supported by the McCrindle research which noted that while every participant knew the benefits of superannuation, and the wisdom of voluntary contributions, not one was, or would do it because while it was true in their head, it was not in their heart 15. A review of some of the behavioural finance research findings provides insights into why this may be the case. The main findings relevant to superannuation are: Self control or present bias The more important the decision, the more people want to do a good job. The more people want to do a good job, the more effort they put into planning. But the more effort they put into planning, the greater the immediate cost and the more people procrastinate 16. In the superannuation context, this means that young people recognise that making decisions about their superannuation is important, but because it is so important, they may feel that they need to plan or obtain more information, and the more effort that is required means the more they procrastinate about making the decision or investigating their options. 13 The Treasury, 2010, Intergenerational Report 2010: Australia to 2050: Future Challenges, Canberra, AGPS p viii 14 FINSIA, above n8, McCrindle, above n2, 8 16 Matthew Rabin 'Thoughts on Behavioural Economics and Financial Literacy' (Presentation delivered at the Australian Bankers' Association Financial Literacy Conference Broadening Financial Understanding Conference, Sydney, 2 June 2010) 6 Loss aversion People feel losses more acutely than gains 17. People are likely to make choices that reduce the likelihood of making a loss, thus reducing the probability of future regret, even if this means they miss out on potential gains. Applied to the superannuation context, where people are already lacking in skills to make good decisions, it creates a barrier to making an active choice for fear of making a wrong decision and incurring a loss, whether it is in choice of superannuation fund, investment option or insurance cover. It is easier to delegate decision making to the superannuation trustee (or its agent). Too many choices The availability of more options does not necessarily result in increased motivation to make a choice. Recent behavioural finance studies have shown excessive options results in 'choice overload', in turn lessening the motivation to choose and the subsequent motivation to commit to a choice. Sethi- Iyengar et al show that, in the context of the US voluntary pension plans 401(k), if a plan offered more funds (or options), this reduced the probability of employee participation in a plan 18. These findings can be applied to the Australian context, where excessive choice may be a barrier to individuals engaging with their superannuation. Inertia and Procrastination Inertia and procrastination are two of the greatest barriers to engagement. Superannuation is a longterm investment, and can't be accessed until retirement age, so people tend not to think about it, or want to think about it until they are closer to retirement. Young people find it hard to see superannuation as 'their' money, or to even conceptualise retirement, which can lead to inertia, disengagement and procrastination. Framing and default bias The default option can have a powerful effect on decision making 19. When making decisions, individuals tend to adopt heuristics (shortcuts), particularly when the decision is complex or difficult. One heuristic is to accept the available default option. In superannuation, the availability of a default option can be a barrier to engagement. If a person considers that the choice of an investment option is too difficult, it is easier to defer to the default option, rather than spending any time considering their superannuation, including optimal investment allocation. Barrier 2 Life barriers People under 40 are more likely than other demographic groups to have other competing saving goals, primarily, saving for a house, but also possibly for education expenses and expenses relating 17 Tversky and Kahneman 1992, cited in Richard H.Thaler and Shlomo Benartzi, 'Save More Tomorrow: Using Behavioural Economics to Increase Employee Saving' (2004) 112 Journal of Political Economy 164, Sheena Sethi-Iyengar et al 'How much choice is too much? Contributions to 401(k) retirement plans' in Mitchell, Olivia S. and Utkus, Stephen P., (eds) Pension Design and Structure: New Lessons from Behavioural Finance (Oxford University Press, United States, 2004) 83, Sunstein and Thaler 2003 cited in Sheena Sethi-Iyengar et al 'How much choice is too much? Contributions to 401(k) retirement plans' in Mitchell, Olivia S. and Utkus, Stephen P., (eds) Pension Design and Structure: New Lessons from Behavioural Finance (Oxford University Press, United States, 2004) 83, 92 7 to children. The FINSIA research noted that ...the longer the financial objective of home ownership takes to achieve, the longer other financial priorities (such as superannuation) are pushed back... 20. The behavioural finance concept of hyperbolic discounting (part of the category of self-control) assists in explaining this barrier. This is the situation where people place a higher value on money today and place a lower value on money in the future. Where there are competing saving goals, young people are less likely to be engaged with their superannuation (whose payoff will be received a long time into the future) when they have more immediate priorities. Barrier 3 System and product operation Systemic aspects of the superannuation system create barriers to engagement. For example, the process for combining multiple superannuation accounts or switching is currently extremely difficult, and is largely paper based. The administrative requirements, including obtaining certified copies of identification and completing forms which require specific information not readily obtained (such as the Superannuation Identification Number of the relevant fund) deters people from combining accounts, and thus taking charge and engaging more with their superannuation. The predominant paper-based system contrasts with other processes, such as buying car insurance, which can easily be done online. The low use of technology by superannuation funds to interact with young people may be a specific deterrent for those who have grown up using it as part of their daily lives. It can also be difficult for members to access information about their superannuation account. To review superannuation account balances often requires logging into a separate website, which may not be accessed regularly. Information that is provided by the superannuation fund is infrequent. These factors are not set in stone, but are a product of how the superannuation system has evolved. The system design, with its combination of compulsion and choice, is a barrier to engagement. Young people are automatically enrolled in a superannuation fund, often starting with casual employment. However, at the same time, the system assumes that an individual will make active choices in relation to their superannuation fund from the beginning of enrolment. The existence of a default options means that people are not required to make active choices, and can, effectively 'switch off'. Barrier 4 knowledge barriers (the concept of superannuation) Superannuation is complex, it is hard to understand and it is boring. These factors are large hurdles to overcome in increasing engagement. The behavioural finance finding of 'bounded rationality' suggests that it may be too much to expect people to have the skills to make good decisions in relation to their superannuation on their own. 20 FINSIA, above n8, 27 8 Research demonstrates that to make good decisions about retirement savings, people require specialised factual knowledge, numeracy and lit
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