COL­LEC­TIVE IN­SIGHT: HOW DE­FAULTS CAN CHANGE YOUR PEN­SION POT

If you are an em­ployee who re­ceives some form of em­ployee ben­e­fits, your pen­sion fund prob­a­bly al­ready uses a de­fault in­vest­ment op­tion.

Finweek English Edition - - FRONT PAGE - By Anne Cabot-Al­let­zhauser

be hon­est – when you saw that this edi­tion of Col­lec­tive In­sight was all about de­faults, which of the fol­low­ing dic­tionary ex­pla­na­tions of that word was the one that first popped into your head? dɪˈfɔːlt de­fault noun

1. fail­ure to do some­thing re­quired by duty or law – such as pay fi­nan­cial debts

2. a se­lec­tion made usu­ally au­to­mat­i­cally or with­out ac­tive con­sid­er­a­tion due to lack of a vi­able al­ter­na­tive Given our hy­per­sen­si­tiv­ity around our fi­nan­cial well-be­ing these days, my bet is that your mind first raced to “credit de­faults” or “fail­ure to pay fi­nan­cial debts”. In fact, this edi­tion of Col­lec­tive In­sight is ded­i­cated to un­der­stand­ing the lat­ter def­i­ni­tion of “de­fault” – with spe­cific ref­er­ence to the kind of de­faults Na­tional Trea­sury feels we need to in­tro­duce if South Africans are go­ing to achieve the level of sav­ings that they re­quire to en­sure that they do not be­come a fi­nan­cial bur­den on oth­ers.

On some level it would seem that this de­bate might be best suited for trus­tees of re­tire­ment funds or pol­i­cy­mak­ers. But we be­lieve this edi­tion should be es­sen­tial read­ing for any em­ployee who re­ceives any form of em­ployee ben­e­fits from their em­ployer. And that cov­ers most of us.

De­faults will be com­ing to the em­ployee ben­e­fit plan and re­tire­ment fund near­est you – if they haven’t al­ready. Most likely your pen­sion fund al­ready uses a de­fault in­vest­ment strat­egy.

But Na­tional Trea­sury would like to see de­faults be­ing used in re­la­tion to de­ci­sions about preser­va­tion and an­nuiti­sa­tion. And the logic for ap­ply­ing de­faults eas­ily ex­tends to such de­ci­sions as your con­tri­bu­tion rates to your pen­sion fund; the au­to­matic es­ca­la­tion of those con­tri­bu­tions over time as your salary in­creases (auto-es­ca­la­tion); and the shift in your risk ben­e­fit cov­er­age as you progress through dif­fer­ent life stages.

The link be­tween de­faults and sav­ing

Why has this con­cept of de­faults be­come so im­por­tant to your fi­nan­cial wel­fare? At the heart of this de­bate (and it’s turn­ing into a par­tic­u­larly con­tentious one) is the well­doc­u­mented ob­ser­va­tion that we mem­bers of the hu­man race (not just South Africans) are not par­tic­u­larly good at for­mu­lat­ing the right long-term sav­ings and fi­nan­cial pro­tec­tion strate­gies to en­sure that we do not be­come a bur­den on oth­ers over the course of our fi­nan­cial jour­ney.

When South African em­ploy­ers be­gan shift­ing their em­ploy­ees out of de­fined ben­e­fit funds, where the em­ployer made all the de­ci­sions on be­half of their mem­bers, and into the de­fined con­tri­bu­tion model of re­tire­ment sav­ings, sud­denly this fi­nan­cial plan­ning re­spon­si­bil­ity was shifted di­rectly to the shoul­ders of the savers.

As Olivia Mitchell and Stephen Utkus pointed out in their sem­i­nal piece on pen­sion fund de­sign and hu­man be­hav­iour, “get­ting this de­ci­sion-mak­ing right meant that the hu­man brain would need to have the ca­pac­ity to solve many decade-long time-value of money prob­lems with mas­sive un­cer­tain­ties as to sto­chas­tic cash flows and their tim­ing” i.e. we hu­mans weren’t likely to fig­ure this one out on our own.

En­ter the con­cept of de­faults. On some level the con­cept of de­faults is bril­liant. Get the pro­fes­sion­als to work out all the com­plex mod­el­ling re­quired to make sure that mem­bers of re­tire­ment funds get the strat­egy they re­quire to meet that re­tire­ment in­come fund­ing; em­bed this think­ing into a se­ries of pro­cesses and funds (pre- and post-re­tire­ment) and then set it as a de­fault

Sud­denly this fi­nan­cial plan­ning re­spon­si­bil­ity was shifted di­rectly to the shoul­ders of the savers.

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