How the Government is applying nudge theory to pension auto enrolment

Sometimes a gentle hint is all it takes, and the Government’s use of nudge theory is starting to bear fruit with its pension auto enrolment initiative. But that’s just for starters. Get set for nudge-plus, writes Public Finance’s Mike Thatcher

Who says apathy is a bad thing? When it comes to saving for our futures, a preference for doing nothing can be used to good effect.

This is exactly what the Government has done with its policy of pensions auto enrolment. Since October last year, large employers have been forced to set up company pension schemes and enrol all workers aged 22 and over who earn more than £8,105 a year.

Eventually, all employers will be covered. Employees can opt out, but they have to make a conscious decision to do so. The Government is banking on our preference for the status quo – and it seems to be working.

Pension auto enrolment’s ‘stunning’ first phase

In March, pensions minister Steve Webb said feedback from the first phase of auto enrolment had been ‘stunning’. He quipped that he would spend 2013 going up and down the country ‘stirring up apathy’.

According to the National Employment Savings Trust, the workplace scheme created by the Government, only 10% of employees have opted out since October. Auto enrolment is a clever way of persuading citizens to act in their own best interests. It’s an example of the ‘nudge’ thinking much favoured by Conservative politicians.

This eschews legislation or taxation and uses subtler influences to change behaviour, such as peer pressure, a desire to conform and inertia.

Many of the ideas originate from the work of US academics Richard Thaler and Cass Sunstein. In 2003 they coined the apparently contradictory term ‘libertarian paternalism’, which suggests that people can be nudged to act differently while still respecting their right to choose.

The nudge theory explained

The simplest example of a successful nudge is making the default option a positive outcome – as with auto enrolment. But in their 2008 book, Nudge: improving decisions about health, wealth and happiness, Thaler and Sunstein offer a wider range of possibilities.

At Amsterdam’s Schiphol Airport, for instance, the authorities were looking for a way to improve cleanliness in the men’s toilets. They decided to paint a picture of a housefly on the urinals to encourage users to aim at it and, hey presto, spillages were reduced by 80%.

Back in the UK, Thaler has been a huge influence on a Conservative Party searching for ways to cut spending. When it works properly, nudging makes people healthier and happier, while saving money at the same time. It has an obvious appeal not lost on Prime Minister David Cameron.

Shortly after coming to power, Cameron set up the Behavioural Insights Team, known as the Nudge Unit, in the Cabinet Office. Initial projects have not yet made a huge impact, but unit director David Halpern claims his team will eventually save the country billions of pounds.

Halpern points to work with HMRC, where simply telling late payers that most people had already sent in their taxes increased payment rates by 15 percentage points. This should generate £30m of savings each year.

Similarly, a trial with the British Courts Service used personalised text messages to remind people to pay their fines on time. Estimates suggest that, if implemented nationally, this could raise an annual £3m in otherwise unpaid fines and save 150,000 baliff interventions a year.

Nudge plus: how the Government plans to go one step further

These are important initiatives, but they are only a first step. Recently, the think-tank Demos proposed a ‘nudge-plus’ approach that goes further than the original libertarian paternalism concept.

Nudge-plus seeks to actively reward those who do the right thing. For example, supermarket users could be offered discounted gym membership for choosing fresh fruit and vegetables in their weekly shop.

Similarly, some of the savings from the establishment of Neighbourhood Watch schemes could be reinvested in an area through a community cash-back. And what about those who have recently joined a pension under auto enrolment?

Well, they could be incentivised to make a greater commitment to long-term savings beyond the default product. Those who are seen to be taking their retirement planning seriously could be given a rebate on their National Insurance contributions that can be invested in their chosen pension.

This would demonstrate the rewards of taking greater personal responsibility, thus acting as a nudge-plus. Inevitably, there will be criticisms that such an approach is an extension of the ‘nanny state’ – leading critic Claire Fox of the Institute of Ideas has already described nudge-plus as the ‘ugly sister of nudge’.

But if it saves money and makes people live healthier, wealthier lives, it will be hard for the Government to opt out.

Mike Thatcher is the editor of Public Finance magazine

For more information on payroll, pensions and more click the image below

Mike Thatcher is Senior Publications Manager at EY.