The Opt-Out Solution
Americans don’t save enough. In 2005, Americans’ personal savings rate was negative for the first time since the Great Depression ─ instead of piling up savings, we are piling up debt. According to Financial Engines, an investment advisory firm that has surveyed the 401(k) retirement savings plans of 2.8 million people, only 28 percent of savers are on track to retire on 70 percent of our final salaries ─ and 70 percent may not be adequate to pay for health costs or travel. Worse, only one third of American workers participate in 401(k) savings plans at all.
Getting people to save more is a crucial challenge, and you might assume that it’s complex. But some solutions are stunningly simple. The Minnesota-based Deluxe Corporation which provides services to small businesses, has long offered its 5,000 employees the opportunity to participate in 401(k) plans. Enrollment used to be 80 percent, with average savings between 5 and 6 percent of paychecks. Now it is about 90 percent, with savings rates above 7 percent of income.
For a good insight into the peculiarities of human nature, let us examine what Deluxe Corporation did ─ and how this fix could be applied to other problems.
Before 2008, Deluxe’s employees had to send in a form if they wanted to participate in the company’s 401(k) plan. Starting that year, they had to send in a form to elect not to participate. In other words, the 401(k) plan went from opt-in, or voluntary enrollment, to opt-out, or automatic enrollment. Deluxe also changed how much of its workers’ paycheck automatically went into savings. The default savings rate for 401(k) participants was 5 percent of income. Today, it starts at 5 percent but is automatically escalated over two years to 7 percent.
So if you are an employee of Deluxe, what changed? You are still free to participate in a 401(k) plan or not, save as much as you want, and invest how you like. You are still in control. The only thing new is what happens if you do nothing.
“Plan managers have spent untold amounts of money trying to communicate the benefits of saving,” said Lori Lucas, a prominent researcher on employee benefits who is the defined contribution practice leader at Callan Associates, an investment consulting firm. “It does have impact ─ it’s not fruitless. But the transformative power of automatic enrollment is unmatched.”
The administrative cost of shifting to an opt-out system is zero — you just add a “not” to a sentence on a form. Yet this “not” has reaped staggering results. The investment company Vanguard, which administers 3.4 million workers’ 401(k) plans, found that at companies with voluntary enrollment, only 59 percent of employees participated in 401(k) plans. At companies with automatic enrollment, 86 percent did — and that figure is surely an understatement, since it includes all workers at companies that have automatic enrollment, even though the vast majority offer it only to their new employees.
Automatic enrollment also helps people start saving sooner. For employees with six months on the job, Vanguard found that switching to automatic enrollment increased the number participating in 401 (k) savings from 34 percent to 90 percent. (For details, see a 2004 study by James J. Choi, David Laibson and Brigitte C. Madrian of the outcomes of various 401(k) plan designs.)
Automatic enrollment is catching on. While only 5 percent of American companies offered it in 2005, 21 percent did last year (mostly to new hires) and the number will likely continue to rise. Two laws helped the shift. In 2006, the Pension Protection Act offered legal protections and business incentives for companies that switched to automatic enrollment and automatic escalation. And in 2007, a law encouraged companies to change investment defaults from low-yielding to more aggressive portfolios or ones that gradually shift the balance from stocks to bonds as a worker approaches retirement, which is what virtually every money manager recommends. These changes will help millions of Americans better prepare for retirement.
This shift in thinking is the result of new attention to what the University of Chicago professors Cass Sunstein and Richard Thaler call “choice architecture.” (Their book on the topic, “Nudge: Improving Decisions about Health, Wealth and Happiness,” is a lot of fun.) Thaler and Sunstein — the latter is now head the Office of Information and Regulatory Affairs in the Obama administration — want people to be nudged towards good decisions, but to keep their freedom to make bad ones if they choose.
One important way to do this is to reframe the default option. Thaler and Sunstein argue that far from being rational economic actors, humans are easily swayed by how choices are framed. Defaults are sticky — people tend not to change them.
Are we so susceptible to influence that we accept the default choice almost all the time? It seems so — particularly with certain decisions. The rise in savings produced by switching to opt-out comes because a worker signing up for a 401(k) plan is confronted with a decision that has three characteristics. It’s painful — we all know we should save for the future, but nobody wants a lower paycheck today. The benefit is far away — many years or decades. And the decision is complicated. Even people who intend to save get paralyzed when they have to decide what percentage of their income to save and how to invest the money. Those are tough decisions. The temptation is to put them aside till later, when you can explore the options and weigh them carefully. And for many of us — perhaps because we are too busy or never become confident enough to confront the choice — later never comes. When we have to make decisions we don’t feel entirely competent to make, we look to cues from our peers and from experts. If someone we trust tells us that a certain option is recommended, we tend to accept it.
There need to be some caveats here. Businesses can take unscrupulous advantage of the stickiness of a default. Some people who subscribe to computer game downloads, magazines or computer virus-protection services find themselves unwittingly enrolled in an automatic renewal plan — the fine print can be very fine, indeed. An ethical opt-out strategy must include full disclosure and ample opportunity to opt-out.
The opt-out strategy can be applied to many problems — like the shortage of donated organs, for example. In the United States, the average wait time for a donated kidney is 1,121 days. Very high numbers of Americans support organ donation, but relatively few agree to become organ donors. One reason is that the United States has an opt-in program. You have to sign up to be a donor — usually by checking a box on your driver’s license — or your family has to give explicit consent after your death. Families are approached about organ donation immediately after learning that a loved one has died — a terrible, emotional moment when the temptation is to hold on to the loved one by saying no. But many of those families do later regret that decision.
A study by Alberto Abadie, a professor at Harvard’s Kennedy School of Government, and Sebastien Gay of the University of Chicago, suggests that an opt-out program — one that presumes you are a donor unless you or your family says otherwise — might cut down on the number of deaths on organ waiting lists. Many European countries have opt-out organ donor programs. These countries have donation rates that average 25 to 30 percent higher than comparable countries with opt-in programs.
Opt-in or opt-out is not the only thing that matters. Spain, by far the world leader in organ donation, has opt-out. But it also has a national network of transplant coordinators in its hospitals who identify potential donors, talk to their families and manage the transplant process. Every country should have such a network — but it takes money and expertise to build. Switching to opt-out is simple and free.
The same shift has also significantly raised rates of H.I.V. testing in Africa. Four years ago, I visited a hospital in a Johannesburg township of Alexandra where just over half of all pregnant women agreed to take an AIDS test. At the same time at the Chris Hani Baragwanath Hospital in Soweto, 98 percent of pregnant women took an AIDS test. There, women are informed that the test is part of the standard package of prenatal tests. A woman can opt out if she chooses.
This makes a lot of sense. AIDS testing was designed to be opt in back when there was no overwhelming reason for people to know their H.I.V. status, as there was very little that could be done for them if they tested positive. Today, even in the poorest countries, patients who learn they are H.I.V. positive can get lifesaving therapy and pregnant woman can take medicines to avoid passing the virus along to their babies.
The change to opt-out helped Botswana increase acceptance of AIDS tests from 64 percent to 83 percent in just one year. Test rates in clinics in Zimbabwe went from 65 percent to 99 percent with a similar change. In 2004, the United Nations AIDS agency and the World Health Organization began recommending opt-out testing in countries where AIDS is widespread.
All these cases have several qualities in common. People are asked to make a complicated or emotionally fraught decision. They have the right to answer how they please, but society has an interest in encouraging one of the choices. That choice, however, is one that can cause discomfort to the decider. Opt-out can preserve their right to choose while still encouraging them to do what’s right.
There are surely many other valuable public projects that would benefit from an opt-out system. Automatic voter registration? A default of escalating charitable contributions? I challenge readers to think of some.
This column was originally published in The New York Times. Fixes appears every Tuesday in the Times Opinionator section.