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Welcome David MitchellPresident & CEO Canada’s Public Policy Forum Second National Summit on Pension Reform

Nudgeeconomics and retirement savings David LaibsonRobert I. Goldman Professor of Economics,Harvard University Second National Summit on Pension Reform

Behavioral Economics and Behavior Change Second National Summit on Pension Reform October 2014 David Laibson Robert I. Goldman Professor of Economics Harvard University

Behavioral Economics • Improves economic analysis, by incorporating psychological factors that influence economic behavior. • Identifies optimal policies: • Nudges (soft paternalism): changes in the choice architecture that influence behavior without eliminating any options • Taxes • Strong paternalism (e.g., the savings rate in the CPP)

Opt-in enrollment Opt-out enrollment (auto-enrollment) PROCRASTINATION UNDESIRED BEHAVIOR: Non-participation DESIRED BEHAVIOR: participation START HERE

Active Choice PROCRASTINATION UNDESIRED BEHAVIOR: Non-participation DESIRED BEHAVIOR: participation Must choose for oneself START HERE

Quick enrollment PROCRASTINATION UNDESIRED BEHAVIOR: Non-participation DESIRED BEHAVIOR: participation START HERE

Improving DC participation Opt-in enrollment 40% Quick Enrollment (“check a box”) 50% Active choice (requirement to choose) 70% Opt-out (Auto-enrollment) 90% Participation Rate (1 year tenure) Madrian and Shea 2001; Choi, Laibson, Madrian, Metrick 2002; Choi, Laibson, Madrian 2009 Carroll, Choi, Laibson, Madrian, and Metrick 2009

Have we cracked the savings code? • Automatic enrollment (opt-out) • Re-enrollment (opt-out) • Target date funds (opt-out) • Savings rate escalators (opt-out) • Quick enrollment (opt-in) • Simplification • Education • Matching

Assumptions for simulation • 6.5% guaranteed return • 2% inflation rate • 6% DC saving rate • 100% employer match • No leakage • Start working at age 22 • First job: $35,000 • Start saving at age 22 • 1% real wage growth • 50% Soc Sec replacement • “4% rule” in retirement At retirement: 103% replacement ratio $719,275 DC assets (+ house + Social Security) Laibson (2011)

Taxable withdrawals from retirement accounts among households <55 Source: Argento, Bryant, and Sabelhouse(2014) Billions Leakage grew 17% in 2010

For every two dollars that go into the retirement system about one dollar simultaneously leaks out (before retirement)

A little more realism

Among those households age 65-74: • Median holding of financial+retirement assets: $72,000. • includes all retirement accounts, savings and checking accounts, CD’s, mutual funds, brokerage accounts,… Source: Survey of Consumer Finances; 2013 wave

Net National Savings Rate: 1929-2013 Table 5.1, NIPA, BEA

Psychological origins of undersaving Would you like to have A) 15 minute massage now or B) 20 minute massage in an hour Would you like to have C) 15 minute massage in a week or D) 20 minute massage in a week and an hour

Choosing fruit vs. chocolate Choosing Today Eating Next Week Time If you were decidingtoday, would you choose fruit or chocolate fornext week? Read and van Leeuwen (1998)

Patient choices for the future: Choosing Today Eating Next Week Time Today, subjects typically choose fruit fornext week. 74% choose fruit

Impatient choices for today: Choosing and Eating Simultaneously Time If you were decidingtoday, would you choose fruit or chocolate fortoday?

Impatient choices for today: Choosing and Eating Simultaneously Time 70% choose chocolate

Present bias Immediate events get full weight. Everything else gets half weight. Phelps and Pollak (1968), Akerlof (1991), Laibson(1997)

Procrastination • Exercise has effort cost 6 • Delayed health benefit of 8 • Exercise Today: -6 + ½ [8] = -2 • Exercise Tomorrow: 0 + ½ [-6 + 8] = 1 Akerlof (1991), O’Donoghue and Rabin (1999)

Joining a Gym • Cost of membership: $75 per month • Number of visits: 4 • Cost per visit: $19 • Cost of “pay per visit”: $10 Della Vigna and Malmendier (2006)

Saving intentions vs. saving behavior Out of every 100 surveyed employees 68 self-report saving too little 24 plan to raise savings rate in next 2 months 3 actually follow through Choi, Laibson, Madrian, Metrick (2002)

If you recognize your own self-control problems… • You’ll be willing to tie your own hands • Force tomorrow’s self to do what today’s self isn’t willing to do • Personal trainer • Exercise class • Exercise partner

How to design a commitment contract Participants divide $$$ between: • Freedom account (22% interest) • Goal account (22% interest) • withdrawal restriction Beshears, Choi, Harris, Madrian, Laibson, Sakong (2014)

Initial investment in goal account Freedom Account 35% Goal Account 10% penalty 65% Freedom Account Goal account 20% penalty 43% 57% Freedom Account Goal account No withdrawal 56% 44%

Summary • People have trouble saving because of present bias and other psychological barriers. • We can get 90% of people to “voluntarily” save using auto-enrollment and other nudges. • But half of this money leaks out of the system before retirement. • It’s not yet clear whether nudges are enough. • One more depressing fact: financial education barely moves the needle (even when it’s offered in real time).

In conversation with David Laibson Moderated by:Rob CarrickPersonal Finance ColumnistThe Globe and Mail Second National Summit on Pension Reform

"Guaranteeing" retirement income for Canadians David DodgeSenior Advisor, Bennett Jones Second National Summit on Pension Reform

Presentation by David Dodge at the PPF Summit on Pension Reform Toronto, October 9, 2014 "Guaranteeing" retirement income for Canadians

Retirement income issue • Adequacy of future retirement income is made very problematic by longer life expectancy, population aging, and possibly permanently lower real returns on pension assets • Increased savings and better returns through new pension arrangements and delayed retirement would improve retirement income adequacy

Outline • Review of demographic trends over the next decades • Macroeconomic case for more saving and investment • General implications of demographics for pension arrangements • Sharing of risks and responsibility for saving between workers, employers and governments

Demographics to create stress on pension systems • Two key features of demographics with implications for pensions in Canada: • longer individual life expectancy • aging of population as a whole • Life expectancy at 65 will continue to rise although by how much is uncertain. Current projections call for slower gains in life expectancies than in the past half-century (Graph 1).

Graph 1: Male and female life expectancies at age 65 in Canada Source: Office of the Chief Actuary, Mortality Projections for Social Security Programs in Canada, April 2014.

Two implications of longer life expectancy • Longer life has at least 2 implications: • Risk of lengthening of retirement life relative to working life and/or later retirement. In 2014, retirement age would have to be about 74 years for male labour force participants and 71 years for female participants in order for them to have the same retirement life expectancies as the 65 years of age had in 1966 when the CPP was launched. This compares with an average retirement age of 63 years in 2013 • Escalating spending for the fragile elderly. Such spending per capita rises dramatically with age. Persons 80+ years of age will increase steadily relative to persons 15-64 of age (see Graph 2) and, from the mid-2020s onwards, they will also increase relative to persons 65-79

Graph 2: The population of old-age persons will increase steadily relative to the working-age population • Source: Statistics Canada

Population aging as baby-boom cohorts get older • Canadian population of 65+ years of age to rise to 24% of total population by 2035 from 15% in 2013 as exceptionally large baby-boom cohorts get older • Because of the much faster growth in the population of seniors (65+ years of age) than the working-age population (15-64 years of age), the number of working age persons for each senior person will fall from 4.5 in 2013 to 2.3 by the late 2050s (see Graph 3). This compares with a peak of 7.8 around 1970. Much of the fall occurs over the next 20 years

Graph 3: Ratio of working-age persons to seniors cut by half to 2.3 over the next half century • Source: Statistics Canada, Canadian Demographics at a Glance, June 2014.

Projected steady decline in the ratio of labour force to retired elderly population • Exceptionally large baby-boom cohorts, population aging and continued rise in life longevity will lead to much slower growth in the labour force than in the population of 65+ years of age. • As a result, the ratio of labour force participants to retirees will fall by around 40% from 4.3 in 2013 to around 2.7 in 2031. This cut will occur under a wide range of scenarios about future labour force participation rates. See Graph 4

Graph 4: Projected steady shrinkage of labour force relative to retired population in the next several decades • Source: Statistics Canada, Canadian Demographic at a Glance, June 2014.

The macroeconomic case for more saving and investment • Demographics and, possibly, protracted modest returns on pension assets greatly darken the prospects for adequate retirement income in the decades to come at current saving rates and retirement ages. • Fundamental challenge is how to provide for adequate retirement income for the future population of elderly people without imposing undue burden of taxation on the working population and the business sector • The solution to generate more retirement income in the future is to start now saving and investing more, and doing so more efficiently • Higher household saving rate would underpin higher retirement income directly through larger accumulated household wealth while higher investment rate in physical and other forms of capital would underpin it indirectly by boosting growth in productivity, real income and government revenues

The need for more household saving and delayed retirement • Since 1997, household saving rate has averaged 3.5% (Graph 5). In the last decade or so, households have elected to invest massively in housing, financed by borrowing, rather than in financial assets for retirement. Low interest rates provided a strong incentive for household current consumption and disincentive for saving.

Modest household saving rate since 1997 Graph 5 • Source: Statistics Canada.

The need for more household saving and delayed retirement • To increase household saving for retirement requires: • Higher household saving rate in the working population • Delaying retirement • Delaying retirement would significantly improve the adequacy of retirement income by shortening the retirement period and permitting a larger accumulation of pension assets • Average retirement age in Canada has steadily increased from 61.4 years in 2008 to 63 years in 2013 and is expected to rise much further • Even with increased age of retirement, a higher retirement saving rate will be required, especially if real interest rates remain low

Small negative effects of higher saving rate in very short run but net benefits in the longer run • An increase in the household saving rate will have a small negative effect on aggregate demand in the very short run, an effect which will automatically be offset in part through the exchange rate and fiscal stabilizers and which should be offset by an easier monetary policy and/or increase in public sector or agency borrowing to finance infrastructure investment. • In the longer run, higher household saving will enhance growth of real income and support more adequate retirement income

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