Consumer and decision making about pensions

When we think about decision-making, we often think about it as a single, linear process in which people weigh up the pros and cons of the various options before making a choice. Indeed, this ability to systematically process information in order to reach the best possible decision is the assumption that traditional economics rests on.

However, in real life our decision-making process is often much less straightforward – particularly when it comes to complex decisions like planning for retirement.

In the current retirement income market, we see evidence that consumers:

• Are disengaged from the process, leading to a lack of understanding and last minute decisions made under pressure.

• Fail to shop around properly – if they shop around at all.

• Do not seek guidance or advice, even when it could be in their best interests to do so.

• Choose a suboptimal product when they do make a decision – for example by sticking with their current provider when a higher income is available elsewhere, and rejecting viable options out of hand.

While human behaviour is hard to predict, we know enough about how people work in the real world to be confident of seeing consumers behave in the following ways when the reforms come into effect:

• Not taking up the offer of Pension Wise guidance.

• Making decisions on the basis of unreliable information.

• Withdrawing large sums from their DC pot and not re-investing it sensibly.

• Falling prey to scams and aggressive marketing.

One of the primary reasons behind this deviation from the traditional economic model is that a variety of psychological biases can interact with contextual factors to affect decision-making. These biases include those associated with how we perceive ourselves and the world around us. We see how:

• The challenges associated with planning for retirement can cause us to avoid thinking about it until the last minute. • We are often overconfident in our ability to manage money wisely.

• We unknowingly rely on faulty heuristics to inform our decisions, and misunderstand probabilities as a result.

• Our behaviour is often influenced by how we think other people like us behave.

Our actions and decisions can also be shaped by how we relate to time. Here, we see how people:

• Show time inconsistent preferences, and are unable to relate to their future selves, resulting in seemingly short-term decisions.

• Let small hassles get in the way of reaping large benefits, and fall foul of the planning fallacy.

We can also be affected by how choices are presented to us. For example, we:

• Become overwhelmed when presented with too many options or large amounts of information, leading to bad decisions or no decisions at all.

• Find it difficult to compare options when they have features that are not alignable, or when the options are presented to us one after the other rather than at the same time.

• Show a tendency to stick with the status quo, and frequently favour the default option.

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