Behavioural Economics

Sin­ga­pore is a suc­cess­ful nation which revolves on a national phi­los­o­phy of self-reliance. Through­out our rapid devel­op­ment, we have refrained from becom­ing a wel­fare state. This was made pos­si­ble through the intro­duc­tion of the Cen­tral Prov­i­dent Fund (CPF) in 1955.
There are many exter­nal forces which can hin­der the effec­tive­ness of our CPF sys­tem. One of the most promi­nent are the behav­ioural bias among CPF mem­bers which may poten­tially hurt the CPF’s mis­sion of ensur­ing that work­ers could sup­port them­selves with dig­nity in retirement.

We shall high­light some com­mon behav­ioural bias among CPF mem­bers and the mea­sures under­taken by the CPF board to min­imise its impact.

Bounded Ratio­nal­ity Bounded ratio­nal­ity is the idea that in deci­sion mak­ing, ratio­nal­ity of indi­vid­u­als is lim­ited by the infor­ma­tion they have. Most peo­ple have a strong ten­dency to under­es­ti­mate their post-retirement needs. Accord­ing to the Sin­ga­pore depart­ment of sta­tis­tics in 2010, the life expectancy of an aver­age retir­ing Sin­ga­porean male is 83.  The fig­ure is expected to rise fur­ther due to advances in med­ical tech­nolo­gies. For exam­ple, a young male grad­u­ate spend­ing $1,200 monthly and wish­ing to retire at age 55, will need a lump sum in excess of $860,000 just to ensure self suf­fi­ciency for day to day expenses. This is with­out tak­ing into account increased health­care and hos­pi­tal­i­sa­tion costs in retire­ment years.

Most Sin­ga­pore­ans gen­er­ally can­not envi­sion them­selves liv­ing past age 80.  By mak­ing indi­vid­ual sav­ings com­pul­sory, CPF is able to kill two birds with one stone, namely address­ing the prob­lem of a lack of fore­sight, as well as a lack of discipline.

Hyper­bolic Discounting

The idea of hyper­bolic dis­count­ing states that given two sim­i­lar rewards, humans show a pref­er­ence for one that arrives sooner rather than later.
The CPF Min­i­mum Sum Scheme addresses people’s ten­dency to value short-term usage of CPF monies (E.g. invest­ments, hous­ing or edu­ca­tion) sig­nif­i­cantly over their longer-term retire­ment needs.
Lock­ing up part of the individual’s CPF sav­ings until his retire­ment age and then dis­burs­ing the monies as life­long annu­ity stream con­strains the individual’s abil­ity to over-consume in his early years of retirement.

Loss Aver­sion
Loss aver­sion refers to people’s ten­dency to strongly pre­fer avoid­ing losses to acquir­ing gains. Some stud­ies sug­gest that losses are twice as pow­er­ful, psy­cho­log­i­cally, as gains. For employed CPF mem­bers, the employee con­tri­bu­tion is deducted directly from their income before they are paid monthly; this reduces the feel­ing of loss among CPF mem­bers.
The Medishield pro­gramme is also a good exam­ple of CPF’s appli­ca­tion of loss aver­sion prin­ci­ples.  By mak­ing medishield an auto­matic enrol­ment and an opt-out scheme, an indi­vid­ual will tend to feel he is los­ing some­thing if he were to opt out; this encour­ages CPF mem­bers to stick to the default option of stay­ing with medishield.

Can behav­iour­ial eco­nom­ics save us from ourselves?

Sta­tus Quo Bias.

Sta­tus Quo Bias sug­gests that peo­ple tend not to change an estab­lished behav­iour unless the incen­tive to change is com­pelling.
Many Sin­ga­pore­ans are unaware of the mechan­ics of med­ical insur­ance, term & mort­gage insur­ance and whole life annu­ities. If these indi­vid­ual deci­sions are to be left to CPF mem­bers, the com­plex­ity of these finan­cial prod­ucts would prob­a­bly result in CPF mem­bers post­pon­ing their deci­sions and being severely underinsured.

As a result, the CPF board has designed these pro­grams such that they are on an opt-out basis. Exam­ples include medishield, depen­dent pro­tec­tion scheme, home pro­tec­tion scheme and CPF Life. Even for the all impor­tant deci­sion of a life­long annu­ity scheme, CPF life, the default option for retir­ing CPF mem­bers is also set as the “Bal­anced” plan, which is deemed to be the pre­ferred option.

Self Serv­ing Bias­Self Serv­ing Bias is the ten­dency to claim more respon­si­bil­ity for suc­cesses than fail­ures.  The CPF Invest­ment scheme has allowed mem­bers to invest in stocks, unit trusts, prop­erty funds and even gold due to the vary­ing invest­ment appetites of CPF mem­bers. This has encour­aged savvy mem­bers who want to take charge of their invest­ment returns to actively man­age their CPF monies so they can attribute invest­ment returns to their indi­vid­ual skills rather than earn­ing a sta­ble fixed rate of inter­est in the CPF account.

Sta­tis­tics paint a dif­fer­ent pic­ture though. As of FY2010, 86% of CPF mem­bers who use their OA for invest­ments are unable to make net realised prof­its in excess of the OA inter­est rate of 2.5%.  In addi­tion, 49% of CPF mem­bers who invested lost monies in their investments,

In order to curb the self serv­ing bias which encour­ages CPF mem­bers to invest for the sake of invest­ing, the CPF board have indi­cated that only amounts in excess of $20,000 in Ordi­nary Account and/or more than $40,000 in their Spe­cial Account can be used for invest­ments (As of Sep 2011).  It is likely that this limit will be fur­ther increased in the future if the trend of invest­ment losses suf­fered by CPF mem­bers continue.

Con­clu­sion
Does the ends jus­tify the means? Most Sin­ga­pore­ans suf­fer from infor­ma­tion over­load as well as atten­tion scarcity, leav­ing deci­sion mak­ing to CPF mem­bers can result in choice para­dox and can have unin­tended neg­a­tive con­se­quences. Sub­sti­tut­ing the invis­i­ble hand of the mar­ket with the hand of the gov­ern­ment, may not be a bad idea after all, even for the most cru­cial life deci­sions such as retire­ment planning.

Writ­ten by Gary Tay