BDI Models and its Application to Retirement Savings

BDI Models and its Application to Retirement Savings

Anand S. RaoDiamond Management & Technology Consultants

SABE-2007 Presentation

May 18, 2007

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© 2006 Diamond.

Contents

• Inadequate Retirement Savings

• Key Retirement Decisions & Barriers to Decision-Making

• Goal-directed and Reactive Investment Planning (GRIP)

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Inadequate Retirement Savings Mistaken beliefs amongst the majority of workers is one of the contributing factors for inadequate retirement savings

A large proportion of the US population, the ‘boomer’ generation, is entering the retirement stage, but are not saving enough to maintain their standard of living

and provide for health, longevity risk, and long-term care

People expect to work longer than they actually do

People think they are saving more than they really are

People think they have more pension coverage than they do

People underestimate the age at which they will receive social security

Workers consistently underestimate what percentage of pre-retirement income is needed during retirement

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Inadequate Retirement Savings More than 50% of late boomers and retirees are ‘at risk’ of being unable to maintain pre-retirement standard of living

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Inadequate Retirement Savings People expect to work longer and the amount of savings for retirement, excluding employer contribution is very close to zero

People expect to work longer than they actually do

People think they are saving more than they really are

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Inadequate Retirement Savings People expect to have more pension coverage and also expect social security to be available earlier

People think they have more pension coverage than they do

People underestimate the age at which they will receive social security

Eligibility for social security payment increasing from 62 to 67 by 2022

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Inadequate Retirement Savings Majority of workers estimate 50-85% of pre-retirement income as being adequate while the current income of retirees is 95% or above

Workers consistently underestimate what percentage of pre-retirement income is needed during retirement

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Contents

• Inadequate Retirement Savings

• Key Retirement Decisions & Barriers to Decision-Making

• Goal-directed and Reactive Investment Planning (GRIP)

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Key Retirement Decisions and Barriers to Decision-Making Retirement planning involves four key decisions regarding enrollment, contribution rate, choice of asset allocation and ongoing portfolio balancing

EnrollmentContribution

RateAsset

AllocationPortfolio Re-

Balancing

Key Retirement Decisions

Inertia to act

Key Barriers to Decision Making

ProcrastinationLack of self-control

Complexity of products Explosion of choices Customer ignorance

Should I enroll in a retirement savings plan (e.g., 401k) or

not?

How much should I contribute every

pay period?

How to allocate the funds across different

asset classes?

How to change the contribution rate and asset allocation over time and in

response to life events?

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Key Retirement Decisions and Barriers to Decision-Making Behavioral economics inspired interventions, such as the US Pension Protection Act 2006, aim to address the barriers to decision-making

Pension Protection Act

Automatic Enrollment• Automatic enrolment of employees in 401(K) and

403(b) plans with explicit opt-out instead of voluntary opt-in

Automatic Increases• Employers can automatically increase the

percentage of an employees salary that is directed to the plan

• Employers are encouraged to meet certain minimum requirements when matching automatic deductions with additional employer contributions

Default Investment• Employers can default their employees into broadly

diversified investments– Balanced Funds– Lifestyle Funds– Managed Accounts

Advice• Asset managers can offer investment advice for

employer-sponsored defined contribution plans• Use of third-party approved computer models for

specific investment recommendations

Source: EBRI and Investment Company Institute, Press Clippings, Company Websites, Diamond Research

Complexity of products

Explosion of choices

Customer ignorance

1

2

3

4

1

Procrastination 1 2

3

3

3

Inertia to act 1 2 3

4

4

4

Key Barriers Addressed

Lack of self-control 2 43

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Key Retirement Decisions and Barriers to Decision-Making SMaRTTM or Save More Tomorrow offers a prescriptive savings program that was trialed by retirement solution providers (e.g., Vanguard, John Hancock)

SMaRTTM

Precommitment• Employees are approached to increase their

contribution rates well before their scheduled pay increase

Loss-Aversion• For employees who join the program the

contributions are increased from the first paycheck after the raise to mitigate against perceived loss-aversion of a decrease in take-home pay

Auto-Increase: • The contribution continues to increase at each

scheduled raise until a preset maximum is reached, exploiting the human inertia to the benefit of long-term savings

Opt-Out: • The employee can opt-out of the plan at any time.

This gives greater confidence to the employees and encourages them to join

Source: Thaler, R.H., and Shlomo Benartzi, 2004. Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving, Journal of Political Economy; Diamond Analysis

Complexity of products

Explosion of choices

Customer ignorance

1

2

3

4

1

Inertia to act 1 3

Key Barriers Addressed

Lack of self-control 2 431

Procrastination 1 3

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Key Retirement Decisions and Barriers to Decision-Making Both behavioral economics inspired interventions have proven to be successful in increasing number of people enrolling and increasing savings rate

Results of Interventions

Auto-enrollment substantially increases participation across all

customer segments

Significant increase in average savings rate

amongst SMarTTM participants

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Contents

• Inadequate Retirement Savings

• Key Retirement Decisions & Barriers to Decision-Making

• Goal-directed and Reactive Investment Planning (GRIP)

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Goal-directed and Reactive Investment Planning (GRIP) The BDI model has been used to build software agents that can make decisions and act with limited resources in complex, uncertain & changing environments

• Environmental Characteristics: Decision-making in environments that are

– Complex

– Uncertain

– Changing

• Decision-maker Characteristics: Decision-maker under resource constraints

– Time

– Computational power

– Memory

Mars Rover• Unknown terrain• Complex set of tasks• Changing environment• Limited computational

power on-board• ……

Robotics• Complex path planning• Obstacles• Limited time to sense-

plan-act• Limited computational

power to analyze all possibilities

• ….

ExamplesCharacteristics

Source: Influential Paper Award of the decade awarded by IFAAMAS -2007 for Modeling Rational Agents within a BDI Architecture, Originally published in 1991

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Goal-directed and Reactive Investment Planning (GRIP) The three attitudes of the BDI model have been used to balance goal-directed long-term behavior and reactive short-term behavior under resource constraints

Beliefs• Informational

state• Facts about the

world• Beliefs about

other agents

Desires/Goals• Motivational state• Situations agent

wants to be in• Objectives agent

wants to achieve• Committed

desires are goals

Intentions• Deliberative state• Agent commits to a plan of

action• Plans are abstract sequence

of goals

Resource-bounded

Reasoning

Balance between Goal-Directed &

Reactive Behaviors

Belief-Desire-Intention (BDI) Model Key Features

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Goal-directed and Reactive Investment Planning (GRIP) Individuals faced with retirement savings decisions have to make complex decisions under uncertain and changing conditions with limited knowledge

Environment• Complexity – when to save, how much to save, what is the asset

allocation, when and how to change the asset allocation etc.• Uncertainty – interest rates, inflation, longevity of life, cost of

medical and long-term care, market performance, etc.• Change – advances in medicine, technology, life-event changes

(marriage, buying a home, college savings) change in government regulations, social security payments, etc.

Decision-Maker• Time – Preference for current consumption as opposed to future

savings; • Limited knowledge – Balancing a number of needs, explosive

number of investment vehicles and fund choices• Limited cognitive ability – Complex analysis required for

asset allocation, re-balancing, tax-efficient savings etc.

Retirement Savings Situation

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Goal-directed and Reactive Investment Planning (GRIP) Principles used to build software agents can also be used to assist retirement savings and investment planning decision-making

Beliefs• Income needed

to live• Longevity of life• Savings they can

afford

Desires/Goals• When to retire• Standard of

living during retirement

• Level of savings

Intentions• Plan to achieve retirement

goals• Commitment and pre-

commitment to savings• Reconsideration on life-

event changes

Resource-bounded

Reasoning

Balance between Goal-Directed &

Reactive Behaviors

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Goal-directed and Reactive Investment Planning (GRIP) Goal-directed and reactive investment planning is a program that can help in addressing the barriers to retirement savings

Goal-Directed and Reactive Investment Planning

‘Holistic’ abstract long-term plan• Life-stage based ‘abstract’ plan• Investment and retirement savings plan that

addresses all needs – protection, asset accumulation, college savings, tax-efficient savings etc.

Focus on short-term goals• Short-term (annual) goals• Adjustable contribution rate that meets short-term

goals• Automatic asset allocation that meets short-term

investment objectives

Reactive plans• Reconsider investment plan based on life-event

changes (e.g., marriage, birth of child, disability event)

• Rebalance asset allocation based on market changes

Complexity of products

Explosion of choices

Customer ignorance

1

2

3

1

Procrastination 2

3

Inertia to act 2 3

Key Barriers Addressed

Lack of self-control 31

1

1

2

2

2

3

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• A large proportion of the US population, the ‘boomer’ generation, is entering the retirement stage, but are not saving enough to maintain their standard of living and provide for health, longevity risk, and long-term care

• Fundamental behavioral barriers exist that hamper the four key decisions (enrollment, contribution rate, asset allocation, and portfolio re-balancing)

• The Belief-Desire-Intention Model is a behavioral model for building software agents that have limited resources and have to act in a dynamically changing environment. This behavioral model can be applied to retirement savings to address the underlying barriers to key retirement decisions

• Goal-directed and Reactive Investment Plan (GRIP) is a program that with three key features that help savers save for long-term retirement goals, while balancing their short-term and life-event based goals

Conclusion