Want People to Save? Force Them



This brilliantly conceived approach solves thorny behavioral and institutional challenges. Behaviorally, it recognizes that people are not good at two aspects of financial planning for retirement—deciding to save and eliminating risk in later years—and it forces them to act in a better way. At the same time, the system acknowledges that people who enroll in retirement plans are reasonably good at managing their own risk. So investment choices are left to the individual, with limits on too-risky behavior, especially as a person ages, when bad choices can do irrecoverable damage.

Institutionally, Chile has cracked an age-old problem with annuities. It’s risky business to predict how long people will live, so insurance companies charge a high premium to cover that risk, which makes for an inefficient market. Annuities also suffer from an adverse selection problem, further increasing risk. (The classic example of adverse selection is health insurance: The healthiest people are the least likely to opt in, which increases the pool’s riskiness, making health care less appealing for insurance companies and policies more expensive for the people who want them.) By pooling the risk, the Chilean government makes annuities an attractive business with more competition and better prices. And since everyone is forced to annuitize, the adverse selection problem simply disappears.

I was impressed with this system and wondered how it would fly in the United States, where our own mandated savings program—Social Security—undergoes sporadic efforts to privatize it.

I suspect Americans would consider the Chilean system heavy-handed and limiting—a flagrant example of nanny-state control. You can force me to save money when you pry it from my cold, dead hands. Paradoxically, we happily accept deeply controlling (and expensive) regulation on our behavior in other areas with little thought or protest. Consider the strictures we allow on driving. Wear a seat belt. Drive this speed. Bear the cost of air bags. Pollute only this much. Don’t text while driving.

Why do we accept so much government intervention in driving but chafe when it comes to a few simple rules that would help us make better financial decisions? It’s probably not because we think we’re smarter about finances than driving. I think the reason has to do with our ability to imagine negative consequences. Car wrecks have a way of vividly communicating our incompetence as drivers and making the benefits of regulation crystal clear. Poor money management can carry similarly devastating consequences, but they are less readily apparent. Even in times of economic crisis, we don’t recognize our own bad judgment because people around us are in the same boat and we compare our fortune with theirs.

But the inability to see our own irrationality shouldn’t be an excuse to let it go unchecked. We need to analyze what people and markets are good at and what they’re not good at, and use those insights to improve our institutions. Chile’s approach to saving shows us that it can be done, and done well.

This post first appeared at HBR