In testimony before the Advisory Council on Employee Welfare and Pension Benefit Plans, more commonly known as the ERISA Advisory Council on August 23, 2016, University of Michigan’s Robert L. Dixon Collegiate Professor of Business and Arthur F. Thurnau Professor of Business Dana M. Muir had a message for the Department of Labor’s council: if you want to understand why employees roll over their DC pension plans from their old employer to their new one, even when it does not appear to be in their best interest, look to behavioral economics.
The ERISA Advisory Council consists of 15 members appointed by the Secretary of Labor. Three members represent employee organizations, three represent employers, three represent the general public. The remaining positions are made up of one representative each from the fields of insurance, corporate trust, actuarial counseling, investment counseling, investment management, and accounting. The duties of the council are to advise the Secretary of Labor and submit recommendations regarding the Secretary’s functions under ERISA.
Professor Muir’s testimony concerned her research, which considers why default rules created based on behavioral economics theory fail to discourage participants from engaging in rollovers from defined contribution plans, even when such actions do not appear to be in their best interest. Based on her research, Muir advised that the Council can increase retirement security for many defined contribution plan participants by (1) discouraging participants from taking actions that are not in their long-term interest, and (2) removing barriers that discourage participants from keeping defined contribution account assets in the defined contribution system.
As a threshold matter, Muir noted that when a participant is deciding whether to remain in a prior employer’s plan, rollover to a new employer’s plan, rollover to an IRA, or take a distribution, there is no single correct choice. Factors to consider include: the fees associated with investments and plans, tax rates, estate planning goals, the number of assets in retirement accounts, an individual’s overall investment portfolio and its level of sophistication, and alternative uses of the funds.
Why do current defaults for defined contribution plan assets sometimes succeed in retaining plan assets, and sometimes fail? Muir says default success is due to transactional barriers and, more importantly for the Council, theories of behavioral economics including anchoring, framing, and endorsement. Professor Muir further explains that when current defaults fail, it is because participants have access to competing plans, or because the decision environment is confusing.
At the end of her testimony, Professor Muir lays out several strategic and practical alternatives for intervention. Her interventions focus on communication timing and access to participants. Each proposed intervention would leverage information about various factors that influence participant behavior. Muir notes that while Congressional action to this end would be optimal, voluntary and regulatory change may be useful to provide a basis for future Congressional actions, and to make some progress in the meantime. Additionally, Muir testified that interventions sought by the Council can be voluntarily made by plan sponsors, mandated without participant choice, mandated with participant opt-out, or a “softer nudge” to participants. The practical interventions Professor Muir proposes are as follows:
- Voluntary Intervention: Using contractual provisions, preclude service plan providers from initiating direct communication about rollovers and distributions until after a participant receives a simple disclosure outlining each of the participant’s options.
- Regulatory Intervention: Preclude any distributions or rollovers for a reasonable minimum time period after the participant leaves employment. To be most effective, there would not be an option to waive the waiting period.
- Statutory Intervention: Require plans to automatically rollover assets to the next employer’s defined contribution plan unless the participant opted otherwise within a particular time period. This leverage’s the principle of anchoring and would be more effective than the current automatic retention default.
- Statutory Intervention: Automatically roll defined contribution account assets into a new employer plan unless the participant meets specific requirements, such as having written advice from a fiduciary advisor or passing a financial literacy test.
The full text of Professor Muir’s comments is posted here.
Patrick Branson ’17 is a 3L at University of Michigan Law School.