Behavioral Economics and Behavior Change

1. Behavioral Economics and Behavior Change David Laibson Robert I. Goldman Professor of Economics Harvard University NIA, May 2011 Funding from the National Institute of Aging.

2. Pension coverage by type of pension plan among all private sector workers in US Defined Contribution Only Both Defined Benefit Only Source: EBRI and Department of Labor

3. $100 bills on the sidewalkChoi, Laibson, Madrian (2010) • In 401(k)’s, employer match is a risk-free high return • 401(k) is particularly appealing if you are over 59½ • Can withdraw money without penalty • We study seven companies and find that on average, half of employees over 59½ are taking full advantage of their employer match • Average loss is 1.6% of salary per year • Educational intervention has no effect

4. Households are retiring with very little financial wealth HRS (65-69): In 2008, the median holding of financial assets is $12,500 among 1-person households HRS (65-69): In 2008, the median holding of financial assets is $111,600 among 2-person households Source: Venti, Poterba, and Wise 2011

5. “If 5 people all have the winning numbers in the lottery and the prize is two million dollars, how much will each of them get?” Fraction of people who answer “400,000” Source: HRS; Agarwal, Driscoll, Gabaix, Laibson (2009)

6. Middle-income retirees are in trouble • Social Security replaces less than ½ of their income. • DB pensions are vanishing. • The median household retires with $200,000 of non-annuitized wealth, most of which is home equity. • OOP health care costs are expected to consume $300,000+ for a two-person household. • These OOP estimates are rising about 10% per year. • Do Americans understand the problem?

7. Procrastination in retirement savingsChoi, Laibson, Madrian, Metrick (2002) • Survey • Mailed to a random sample of employees • Matched to administrative data on actual savings behavior

8. Typical breakdown among 100 employees Out of every 100 surveyed employees 68 self-report saving too little 24 plan to raise savings rate in next 2 months 3 actually follow through

9. Do people want to tie themselves to the mast?Beshears, Choi, Laibson, Madrian, Sakong (2010)(cf. Ashraf and Karlan 2004) • Give subjects a budget ($50, $100, or $500) and ask them to allocate between: • Freedom account (22% interest) • Commitment account (22% interest): restrictions on withdrawal before self-selected goal date, about 100 days in the future • Economically speaking, the Freedom account dominates the Commitment account (Freedom account has greater liquidity)

10. Proportion invested in commitment accountBeshears, Choi, Laibson, Madrian, Sakong (2010) Nature of early withdrawal rule in the illiquid account

11. We don’t know how to contain health care costs, but we do know how to raise savings.

12. DefaultsAutomatic enrollment • An example: Welcome to the company • If you don’t do anything • You are automatically enrolled in the 401(k) • You save 2% of your pay • Your contributions go into a default fund • Call this phone number to opt out of enrollment or change your investment allocations

13. Madrian and Shea (2001)Choi, Laibson, Madrian, Metrick (2004) Automatic enrollment Standard enrollment

14. Do workers like automatic enrollment? • In firms with standard 401(k) plans (no auto-enrollment), 2/3 of workers say that they should save more • Opt-out rates under automatic enrollment are typically only 10% (opt-out rates rarely exceed 15%) • Under automatic enrollment HR reports “no complaints” • 97% of employees in auto-enrollment firms approve of auto-enrollment • Even among the subset of workers who opt out of automatic enrollment, approval is 79% • The US government just adopted automatic enrollment

15. Opt-in enrollment Opt-out enrollment (auto-enrollment) PROCRASTINATION UNDESIRED BEHAVIOR: Non-participation DESIRED BEHAVIOR: participation START HERE

16. Choice-based regimes: Active decisionsChoi, Laibson, Madrian, Metrick (2010) Active decision mechanisms require employees to make an active choice about 401(k) participation. • Welcome to the company • You are required to submit this form within 30 days of hire, regardless of your 401(k) participation choice • If you don’t want to participate, indicate that decision • If you want to participate, indicate your contribution rate and asset allocation • Being passive is not an option

17. 401(k) participation increases under active decisions Active decision Standard enrollment

18. Active Choice PROCRASTINATION UNDESIRED BEHAVIOR: Non-participation DESIRED BEHAVIOR: participation Must choose for oneself START HERE

19. Simplified enrollment raises participation Beshears, Choi, Laibson, Madrian (2006) 2005 2004 2003

20. Quick enrollment PROCRASTINATION UNDESIRED BEHAVIOR: Non-participation DESIRED BEHAVIOR: participation START HERE

21. Quick enrollment PROCRASTINATION UNDESIRED BEHAVIOR: Non-participation DESIRED BEHAVIOR: participation START HERE

22. Improving participation in 401K plans(for a typical firm) Default non-enrollment (financial incentives alone) 40% Quick Enrollment (“check a box”) 50% Active choice (perceived req’t to choose) 70% Default enrollment (opt out) 90% Participation Rate (1 year of tenure)

23. Research Impact:Savings Policy • Motivation behind the “Autosave” features of the Pension Protection Act of 2006 • Regulations contain numerous footnotes to NIA- research. • Motivation behind the “Auto IRA” proposal currently under legislative consideration • Kiwisaver plan in New Zealand • Pensions reform in the U.K. • Myriad other financial reforms across the world.

24. Research Impact: Employer-Sponsored Savings Plans Representing 43% of employees at firms with 401(k) plans

25. Emotional system (dopamine reward system) vs. Fronto-Parietal System Frontal cortex Parietal cortex Dopaminergic Reward Systems

26. Neural mechanisms Stay on your diet (dLPFC) I want a donut (dopamine reward system) McClure, Laibson, Loewenstein, Cohen (2004) McClure, Ericson, Laibson, Loewenstein, Cohen (2007) Hare, Camerer, Rangel (2009) Figner, Knoch, Johnson, Krosch, Lisanby, Fehr, Weber (2010)

27. x = -4mm PCC VStr MOFC MPFC y = 8mm z = -4mm 0.4% 2s = Earliest reward available today = Earliest reward available in 2 weeks = Earliest reward available in 1 month McClure, Laibson, Loewenstein, and Cohen Science (2004) Emotional system responds only to immediate rewards 7 T13 0 Neural activity Seconds

28. 0.4% 2s = Earliest reward available today = Earliest reward available in 2 weeks = Earliest reward available in 1 month Analytic brain responds equally to all rewards VCtx PMA RPar x = 44mm DLPFC VLPFC LOFC x = 0mm 15 0 T13

29. Brain Activity in the Frontal System and Emotional System Predicts BehaviorMcClure, Laibson, Loewenstein, Cohen (2004) Frontalsystem 0.05 Brain Activity 0.0 Emotional System -0.05 Choose Larger Delayed Reward Choose Smaller Immediate Reward

30. Conceptual Summary • Practical solutions that lead to behavior change • Principal application: retirement savings • Neuroeconomic foundations

31. Translation to the health domain Similarities with saving behavior: • Employees and employers have many aligned goals • Improve employee health and control costs • Employees want behavior change (just not right now) • Improve diet • Increase physical activity • Stop smoking • Adhere to therapeutic recommendations

32. Translation to the health domain Similarities with saving behavior: • Employees have a hard time aligning their good intentions and their actions • When costs precede benefits, decision-makers fail

33. Example of an effective free intervention: flu shot communication • Control: normal (informational) mailing • Treatment 1: normal mailing + make a date plan • Treatment 2: normal mailing + make a date/time plan

34. Ask employees to make a precise planMilkman, Beshears, Choi, Laibson, and Madrian (forthcoming 2011, Proceedings of the National Academy of Sciences; under embargo until publication) Flu shot letter Flu shot letter + date plan + time plan Flu shot letter + date plan

35. Use Active Choice to encourage adoption of Home Delivery of chronic medicationBeshears, Choi, Laibson, and Madrian (in preparation) • Voluntary • No plan design change • Lower employee co-pay • Time saving for employee • Lower employer cost • Better medication adherence • Improved safety Member Express Scripts Scientific Advisory Board (All payments donated to charity.)

36. Preliminary results from pilot study on 54,863 employees without home delivery taking chronic medication Among those making an active choice: Fraction choosing home delivery: 52.2% Fraction choosing standard pharmacy pick-up: 47.8%

37. Preliminary results from pilot study at one company Rxsby Mail* After Before * Annualized

38. Summary • Behavioral economics explains why people often fail to act in their own best interest • Key problem • costs come early and benefits come late • Self-defeating behavior can be changed using inexpensive, scalable interventions • Defaults and other nudges have worked in the 401(k) domain • The same concepts are now being applied in the health domain