McClymont: The power of AE inertia is not too powerful

Research by the Institute of Fiscal Studies' (IFS) shows that nine out of ten eligible people are saving into a pension as a result of automatic enrolment.

But the IFS study also shows that a small minority, some 3% of savers, are worryingly financially vulnerable. This small group is likely to be better off stopping saving in a pension, in order to receive a higher income during this period of immense uncertainty.

The opt-out mechanism built into auto-enrolment enables this. The question is whether important financial decisions are not being made by members of this small group because of inertia. That is, is the power of inertia too powerful? 

The behavioural economics debate has come a long way in that sense. Before 2012, policymakers weren't sure whether automatic enrolment would really raise savings rates - opt out rates were expected to be much higher than we have seen.

DWP-commissioned social research in the run-up to auto-enrolment's (AE's) launch eight years ago showed that people were much more likely to accept AE if they had a feeling of control. If the ability to opt out were hidden from them, then they were much more likely to become angry, revolt and opt out. It was important, therefore, that opt out was obvious and easy.

And it is. The two biggest providers of AE pensions in the UK, The People's Pension and Nest, make it easy and it can be done online or over the phone. For example, you do not have to set up your online account with The People's Pension in order to opt out over the web. After eight years of AE, policymakers and pension funds have data to mine which provides important context for the IFS findings. 

Experience of AE in real time has also offered evidence about how inertia actually works. Policymakers knew the research into 401k schemes in the US showed that changing the savings decision from opt out to opt in massively increased the number of people saving for retirement. But the thought processes and patterns of behaviour which underpinned inertia were not so clear.

One explanation offered in theory was that people simply not know that they had been automatically enrolled. The experience of AE suggests otherwise. Right now, we think that only about 15% of those automatically enrolled do not know that they are saving into a workplace pension. The vast majority of those saving are aware and are presumably happy about it or they would stop. This means that lack of awareness is an increasingly weak argument for why AE works as well as it does at scale.

The second potential explanation for the power of inertia in the pensions' context is that, people want to save for retirement and will do so, provided it's done largely on their behalf and with strong financial incentives, through tax relief and the employer contribution. AE appears to work because it aligns the long-term savings decision with what people feel they should do but struggled to do in practice.

The final explanation offered by some is that, because of inertia, people just don't get around to opting out or ceasing contributions. That remains possible but less likely as the largest providers have deliberately made opt outing out easy. Although the modest sums involved in AE statutory minimum contributions for the lowest paid might also be a factor.

In short, the AE system is designed to make stopping saving simple, and to make restarting pension saving through auto-enrolment easy too, via the re-enrolment process. As such, auto-enrolment's design enables it to respond flexibly to the financial pressures on members that the Covid-19 crisis is bringing in its wake.

Gregg McClymont is director of policy at The People's Pension