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Attitudinal Segmentation Of CAP Members

By: Richard Deaves

Not all Defined Contribution pension plans are created equal. Plan sponsors who understand the attitudinal differences of their members can create education and communication programs which provide maximum value to their members, writes Richard Deaves, of the DeGroote School of Business at McMaster University.

In May of 2004, the Joint Forum of Financial Market Regulators released its guidelines detailing best practices for capital accumulation plans. Many sponsors are now in the process of ensuring that their plans are compliant with these guidelines.

A key statement made in the report is that it is important to “ensure CAP members are provided the information and assistance that they need to make investment decisions in a capital accumulation plan.” This article considers what sort of assistance is needed. Is mere communication enough? Perhaps more structured education is required? Or do people need directive advice?

The answers to these questions are far from straightforward. To a great extent, in fact, the answers may be plan-specific or even member-specific. This is because there is increasing evidence that members fall into fairly distinct attitudinal segments when it comes to money and retirement attitudes. The form of assistance required may well be a function of which segment an individual falls into. Communication may be enough for some, for others education is needed, advice is needed by still others, and, finally, judicious defaults, which I view as a strong form of advice, are needed by the rest.

Egregious Mistakes
Let me begin with some brief background on why assistance is needed in the first place. It is quite clear that some CAP members, if left to their own devices, will make egregious mistakes. These mistakes stem from low levels of knowledge coupled with behavioural bias. Saving procrastination can be a problem for many. Risk is not well understood. Some take on an insufficient amount of risk because of fear of regret.

One of the most basic lessons of finance is that no one should pass up the ‘free lunch’ of diversification. Unfortunately, many leave it on the table by poorly diversifying their portfolios. Often chasing the latest hot trend is the cause of this. While people are aware of their lack of knowledge, in most cases they actually think they know more than they really do, and we all know that ‘a little knowledge is a dangerous thing.’

Finally, and perhaps most damning, despite the fact that asset allocation decisions are central to a portfolio’s long-term success, many do not understand how to approach this process.

The need for assistance is clear. Nevertheless, there are nettlesome issues of cost and potential litigation. Who is to pay for it? In my view, ultimately it will be the employee, since even if it is technically provided ‘for free,’ the employer would naturally view it as a component of total compensation.

As for avoiding litigation, neutral communication and education seem safe enough. But when it comes to advice, some sponsors view it with trepidation. Still, the CAP Guidelines say it can be provided. But, if provided, care must be exercised in selecting and monitoring its providers.

Growing Realization
Despite these negatives, there is a growing realization on the part of sponsors that improved education and/or advice must be part of the DC pension deal. In a recent survey of DC plan sponsors, SEI Investments found that 53 per cent believed that educating their members was the most important way to combat litigation. Yet only 11 per cent thought they were performing well in this regard. Another recent survey of DC sponsors, this one by Sun Life Financial, found that 80 per cent of sponsors agree that member education through the sponsor will be a necessity in avoiding litigation. And 59 per cent thought that advice through the sponsor would also be needed to avoid litigation.

There is a new body of research that can be helpful in addressing what sort of member assistance is required and how it can best be offered. It is known as psychographic profiling or attitudinal segmentation. Using a statistical technique known as cluster analysis, attitudinal segmentation attempts to assign individuals to distinct groups based on measurable attributes. For example, people differ in terms of confidence in their investment knowledge, comfort in their pensions, and attitudes toward educational programs.

Research conducted by Vanguard in the U.S. and SEI in Canada analyzes the money ‘personalities’ of retirement account members. While it is true that, like snowflakes or fingerprints, we are all unique individuals, when it comes to ‘money attitudes’ it turns out that we cluster around certain profiles.

Vanguard identified five groups and its key distinction was between ‘planners’ and ‘avoiders.’ Planners are motivated and comfortable with retirement and pension concepts. Avoiders are not comfortable at all. They may not have the time, they may not have the inclination, or they may not have the capacity to become planners.

SEI also identified five distinct attitudinal segments:

Apparently money attitudes in Canada are quite similar to those present south of the border. This is evidenced by the fact that an examination of the above groups also suggests a continuum along a planningavoidance dimension. This is the upper continuum illustrated in Figure 1. The smart guys are the ultimate planners, followed by the participators. The disengaged are the ultimate avoiders, followed by the needy. The seekers fall somewhere in the middle.

Form Of Assistance
Arguably, the form of assistance that would best serve plan members is a function of where they are sited on this continuum. Figure 1 also shows a parallel continuum (below the first) in terms of assistance options.

The smart guys think they only require communication. They want to be informed of the nature of the investment choices available to them, but require little else. They believe themselves already equipped with the requisite skill set. Nevertheless, given their high levels of overconfidence, some education would likely be useful for many of them.

On the other hand, participators desire education. Seminars and retirement planning tools are ideal. Once armed with this knowledge, they feel themselves quite capable of moving forward. Moving to the right along this continuum, the insecurity and/or disengagement readings start to rise.

Seekers need all kinds of help – education and advice.

The needy, however, may not be able to make much use of education. This group may be prime candidates for third-party advice. They need to be steered in the right direction.

Finally, the disengaged are not likely to take advantage of any programs offered by the company. Still they do need help – despite themselves. The best way to reach them is to take advantage of their inertia by designing a pension with intelligent defaults which are designed to enable inactive members to save a sufficient amount in an appropriate fashion. A prime example is one-stop pre-packaged funds with appropriate-tothe- individual diversification over asset classes and styles.

How does all this help sponsors? If a sponsor feels that their workforce is mostly made up of planners, then communication supplemented by some educational programs may be enough. But, if the workforce is skewed towards avoiders, another tack is judicious. Now the pension should be built around third-party advice and/or the provision of pre-packaged funds. Those with a diverse workforce may want to offer a little bit of everything so as to cover the needs of all.

Distinct Mindsets
Attitudinal segmentation can allow this to be done efficiently. The attitudinal segment of each member can, early on, be ascertained by way of a questionnaire. Segmenting members according to their mindsets enables sponsors to offer targeted education and address distinct mindsets and desires more fully. Amore effective approach results that is still manageable in terms of cost.

How might customization pay off?

Take the delivery mode of education. As an educator, I know that mere delivery of information does not automatically lead to retention and understanding. It is easier teaching university students. They have no choice but to be fairly receptive. The deadline for them – their exam – looms large on the horizon. This has the effect of fixing their attention.

But DC plan members are not equally receptive. The deadline of interest to them, retirement, seems very far off. It may be for this reason that researchers have documented a rather small payoff to financial education among DC plan members. If education is to have any impact for avoiders, it must play to their strengths. Avoiders are more likely to be influenced by what is known as an adult-based learning approach. The idea is that education works better if the focus is on the learner, not the information. The intention is to engage members as goal-directed and self-regulated learners, not fact-digesters, and to connect principles to their personal perceptions and experience. Avoiders may not have much in the way of financial acumen or interest, but, like the rest of us, they are armed with rich histories.

In one test of this approach, performed at CIGNA Retirement and Investment Services, call-in agents, who normally answered fairly mundane questions about member DC pensions, were trained to engage callers in a discussion of the benefits of saving and the current deferral rate of the caller. This was not done in a lecturing mode, but, rather, an experiential approach was taken. They became ‘educators in disguise,’ as it were. Deferrals increased dramatically.

Another realm where customization can be used is retirement planning websites. First it is important to get avoiders to visit the sites. Barriers should be minimized.

Inertia And Procrastination
An example is, given the inertia and procrastination of avoiders, it is much better to have an active link in an eMail informing participants about a website than to inform people of this by surface mail. Once there, it is important to keep avoiders there so they use the available tools. Whereas planners are comfortable with a website chock full of data, such an approach is likely to turn off many avoiders.

How can avoiders be encouraged to make use of such facilities? To appeal to an avoider, the front end of a website should be kept simple, appealing, and direct. Complexities appealing to planners can be placed one or more levels down.

The problem of ensuring that plan members have sufficient savings as they approach retirement is far too important to both members and sponsors not to devise approaches that lead to optimal member behaviour while keeping decision-making in their court. Attitudinal segmentation appears promising as a new technique in this toolkit.

Richard Deaves is chair of finance at the DeGroote School of Business at McMaster University.

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