The choice conundrum

I wrote quite a while back about the White Paper on Personal Accounts and some of the behavioural insights in it. I thought it would be useful to pick out some key bits for anyone who is (like me) sad enough to be interested in how choice works, or not, in financial services. I think some of the analysis here is really pretty radical, and could probably be applied elsewhere -choice in health provision being an obvious example.

For info the excerpts below are all taken from pages 69-75 of the White Paper.

General consumer attitudes to choice in pensions:

Research evidence consistently indicates that many UK consumers find choices in pensions , including investment fund choice , overwhelming. This is one of the reasons why many do not choose to save voluntarily and are reluctant to seek information. This is particularly true of the target market. Evidence from both qualitative , and quantitative research , reveals a widespread lack of confidence among UK consumers in their ability to make decisions about pension provision. This lack of confidence is underpinned by low levels of financial capability, particularly among younger groups.

On investment choice:

The majority of the target group for personal accounts do not want to be faced with a choice over investments or administration of their pension, but a significant minority do. This minority tend to be younger or be higher earners, who have higher levels of confidence in their ability to choose and greater familiarity with financial choices.

Consumers lack confidence to make investment choices – evidence reveals a lack of confidence among UK consumers about investment fund choice. This is compounded by low levels of financial capability, particularly among younger groups and with regard to financial product choice.

Too much fund choice can be confusing – focus group discussions have suggested too much fund choice would make the scheme more complicated and confusing than it needs to be and that it would be likely to increase opt out rates. Findings from the US 401(k) scheme15 found that larger numbers of fund choices significantly reduced participation levels.

Consumers want structured choice – research indicates a shortlist of funds would provide choice for those who want it whilst minimising complexity, although overall no choice was generally preferred.

Choice needs to be appropriate – research evidence shows that where consumers choose their own investment, a substantial proportion adopt a ‘naïve diversification’ strategy, in which money is divided equally among a number of funds irrespective of the underlying asset composition of the funds. So, consumers who do exercise choice may not necessarily make the right decisions. Findings also show that investments are influenced by recent returns in the market, implying that the timing of the launch of the programme can have a strong impact on the asset allocations of the participants. This effect can be long-lasting because very few participants have altered their portfolios.

Here's a good bit on the role of competition:

In all the provider models, companies compete to get individuals to join their scheme. As people can switch between providers they can move to one with the lowest charge or the best service according to their judgement.

This argument only works if individuals are well informed about the market. They would need to be able to see which is the best provider or the best fund. Evidence suggests the target group are not well informed about this particular market. They find pensions confusing: they shy away from making decisions and their concern about making the wrong choice often means that they do not make any.

We have considered the competitive impact of each model in some depth. We do not believe the arguments are conclusive for either an NPSS or a provider choice model, but evidence shows that in the current pensions market competition does not always work to the customer’s benefit.

The Sandler review showed that there was little evidence that choice and competition in the pensions market drove down costs. The Pensions Commission26 showed that the reductions in charges that many people now benefit from were caused by regulatory changes – such as the introduction of stakeholder pensions and changes in the charge cap – rather than competitive forces.