JAMES J. CHOI, Yale School of Management, National Bureau of Economic Research (NBER)
Email: jameschoi@yale.edu
DAVID LAIBSON, Harvard University - Department of Economics, National Bureau of Economic Research (NBER)
Email: dlaibson@harvard.edu
BRIGITTE C. MADRIAN, Harvard University - John F. Kennedy School of Government, National Bureau of Economic Research (NBER)
Email: brigitte_madrian@harvard.edu

We document a flypaper effect in asset allocation: securities received in kind stick where they hit. We study a firm that twice changed the rules governing the securities in which its 401(k) matching contributions were initially invested. Both of these rule changes were economically neutral: employees were always free to immediately reallocate their match account balances. However, we find that most employees neither reallocate their match balances, nor offset employer-initiated changes in the match allocation by adjusting the allocation of their own contributions. Consequently, these rule changes caused dramatic shifts in participants' 401(k) portfolio risk. After examining several alternative explanations for this flypaper effect, we conclude that it is largely due to a combination of passivity and mental accounting.

JEFFREY R. BROWN, University of Illinois at Urbana-Champaign - Department of Finance, National Bureau of Economic Research (NBER)
Email: brownjr@uiuc.edu
JEFFREY R. KLING, Brookings Institution, National Bureau of Economic Research (NBER)
Email: jkling@brookings.edu
SENDHIL MULLAINATHAN, Harvard University - Department of Economics, National Bureau of Economic Research (NBER)
Email: mullain@fas.harvard.edu
MARIAN WROBEL, Harvard University - Institute for Quantitative Social Science
Email: mwrobel@iq.harvard.edu

Rational models of risk-averse consumers have difficulty explaining limited annuity demand. We posit that consumers evaluate annuity products using a narrow investment frame that focuses on risk and return, rather than a consumption frame that considers the consequences for lifelong consumption. Under an investment frame, annuities are quite unattractive, exhibiting high risk without high returns. Survey evidence supports this hypothesis: whereas 72 percent of respondents prefer a life annuity over a savings account when the choice is framed in terms of consumption, only 21 percent of respondents prefer it when the choice is framed in terms of investment features.

ANNAMARIA LUSARDI, Dartmouth College - Department of Economics, National Bureau of Economic Research (NBER)
Email: annamaria.lusardi@dartmouth.edu
OLIVIA S. MITCHELL, University of Pennsylvania - Insurance & Risk Management Department, National Bureau of Economic Research (NBER)
Email: mitchelo@wharton.upenn.edu

Many older US households have done little or no planning for retirement, and there is a substantial population that seems to undersave for retirement. Of particular concern is the relative position of older women, who are more vulnerable to old-age poverty due to their longer longevity. This paper uses data from a special module we devised on planning and financial literacy in the 2004 Health and Retirement Study. It shows that women display much lower levels of financial literacy than the older population as a whole. In addition, women who are less financially literate are also less likely to plan for retirement and be successful planners. These findings have important implications for policy and for programs aimed at fostering financial security at older ages.

ALISTAIR BYRNE, University of Edinburgh - School of Management and Economics
Email: alistair.byrne@ed.ac.uk
DEBBIE HARRISON, City University London - Sir John Cass Business School
Email: debbie.harrison@virgin.net
DAVID P. BLAKE, City University London - Cass Business School - The Pensions Institute
Email: d.blake@city.ac.uk

This report is the first major study of DC investment strategies used in UK defined contribution pension schemes. It is critical of 'traditional' arrangements and urges employers, trustees, and pension practitioners to consider innovative strategies for the default fund, in which the majority of members invest. It also calls on the regulators to introduce 'safe harbour' rules to enable parties to the scheme with relevant expertise to provide much clearer advice to 'reluctant investors', who are unable or unwilling to make active investment choices.

ANDERS KARLSSON, Stockholm University - Department of Corporate Finance
Email: aka@fek.su.se
LARS L. NORDEN, Stockholm University - School of Business
Email: ln@fek.su.se

According to Heath and Tversky (1991), people are more willing to bet on their own judgments in areas where they consider themselves more knowledgeable or competent. We analyze the competence effect in the context of individuals' choices in their own pension accounts. We find that individuals with a high own perceived competence regarding the new Swedish pension system are more likely to actively choose mutual funds in their own accounts, whereas individuals with a low perceived competence are less likely to make an active choice. We also find a significantly positive relationship between an individual's information processing and perceived competence, consistent with the notion that competence is enhanced information processing, and diminished by calling to attention information that is not available to the individual.

ANNAMARIA LUSARDI, Dartmouth College - Department of Economics, National Bureau of Economic Research (NBER)
Email: annamaria.lusardi@dartmouth.edu

Individuals are increasingly in charge of their own financial security after retirement. But how well-equipped are individuals to make saving decisions; do they possess adequate financial literacy, are they informed about the most important components of saving plans, do they even plan for retirement? This paper shows that financial illiteracy is widespread among the U.S. population and particularly acute among specific demographic groups, such as those with low education, women, African-Americans, and Hispanics. Moreover, close to half of older workers do not know which type of pensions they have and the large majority of workers know little about the rules governing Social Security benefits. Notwithstanding the low levels of literacy that many individuals display, very few rely on the help of experts or financial advisors to make saving and investment decisions. Low literacy and lack of information affect the ability to save and to secure a comfortable retirement; ignorance about basic financial concepts can be linked to lack of retirement planning and lack of wealth. Financial education programs can help improve saving and financial decision-making, but much more can be done to improve the effectiveness of these programs.

KATHRYN J. KENNEDY, John Marshall Law School
Email: 7kennedy@jmls.edu

The Pension Protection Act of 2006 now mandates certain automatic disclosure of benefit statements, as well as more timely and expansive disclosure, to ERISA participants and beneficiaries, effective beginning in 2007. While the Department of Labor (DOL) provided good faith reliance regarding these requirements through a field assistance bulletin, that guidance left plan sponsors and third party administrators with a number of unanswered questions.

Due to the importance of these issues, one of the 2007 Working Groups for the DOL's ERISA Advisory Council has scheduled testimonies for the summer and fall of 2007 so as to provide recommendations to the DOL by November of 2007. To facilitate in the dialogue between the employee benefits community and the DOL, this article explains the new requirements in light of prior proposed regulations (issued under prior law) and the recent field assistance bulletin, and then provides a suggested blueprint for change, that hopefully will result in meaningful disclosure to participants and beneficiaries without unduly burdening plan administrators. When writing the regulations, the DOL will need to balance meaningful disclosure of benefits with the administrative impacts and costs of such disclosure for covered plans.

The author concludes that these new requirements will have a significant impact on the administrative burdens and costs of employee benefit plans, which unfortunately in the defined contribution plan model, may be passed along to the participants and beneficiaries either directly or indirectly.

DAVID A. LOVE, Williams College - Department of Economics
Email: dlove@williams.edu

Marriage, divorce, and widowhood are major life events that can potentially lead to sharp adjustments in a household's expectations and financial decisions. This paper investigates how changes in marital status affect optimal decisions about saving, life insurance, and, most centrally, asset allocation. We analyze these choices by solving and simulating a life-cycle model that features exogenous changes in family composition, heterogeneity in lifetime earnings, and uninsurable fluctuations in earnings and medical costs. Simulation results indicate that marital status transitions (or family shocks) have a first-order effect on optimal consumption, life-insurance, and portfolio decisions. Widowhood, for instance, induces a sharp downward adjustment in the optimal share of risky assets for both men and women, with an especially large effect for college-educated women in the decade before retirement. Divorce affects men and women differently. While men optimally reallocate toward stocks, women shift their portfolios toward safer assets. Comparing our simulation results with evidence from the Health and Retirement Study, we conclude that changes in marital status matter in practice, but not as much as the model predicts.