Yves Nosbusch

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The way options are presented and its surprising impact on choices

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We make countless choices in our everyday lives, from the configuration of our telephone to deciding whether or not to invest in a private pension plan for instance. These situations usually involve a “default” option. This is the solution we get if we do not actively choose another option. More broadly, how are our choices influenced by the menu of options presented to us? A number of studies in a range of fields have shown that the way the default option and the menu of available options are expressed has an enormous influence on outcomes, even in situations where it does not constrain people in any way.

 

In or out?
A particularly vivid example of the importance of the default option comes from a study on the employer pension plan of a US company by David Laibson of Harvard University and several co-authors. In a first regime, referred to as “opt-in”, employees were not enrolled in the plan by default and if they wanted to invest, they had to inform the company. In a second regime, the employees had to fill out a form which asked them to choose (yes or no) if they wanted to enroll in the plan, thus requiring an “active decision” on their part. Laibson and his co-authors estimate that for this company, switching from the “opt-in” regime to the “active decision” regime increases enrollment in the plan by 28 percentage points! Similar results have been observed for switches from an “opt-in” regime to an “opt-out” regime, i.e., a system where, by default, employees are enrolled in the plan and they have to fill out a form if they do not wish to participate. The key point of course is that these regime changes have no effect on the options available to employees. They just push them to make a choice that, for many of them, they would otherwise simply have postponed.

The decision-making “inertia” highlighted by the “opt-in” system ties in with the idea of how human preferences may be inconsistent over time, a concept discussed in a previous article in this series. We often have good intentions, such as saving more in a private pension plan, but we prefer to postpone actually doing so.

 

“Naïve” diversification
Other studies, notably those of Richard Thaler from the University of Chicago and his co-authors, have demonstrated that people often fall back on simple rules when faced with complex and important choices. A notable example is the so-called “1/n heuristic”, whereby people allocate a fraction 1/n to each option among n options presented to them. A consequence is that the final allocation may depend to a significant extent on the displayed menu of options. These researchers provide a striking example of this phenomenon in the context of the employer pension scheme of a US university. A first group of employees had a choice between four equity funds and one bond fund. A second group of employees - chosen at random - had the choice between four bond funds and one equity fund. The overall portfolio allocation to equities of the participants in the first group was equal to 68% on average. In the second group, it was equal to 43%. The consequence of a “naïve” diversification strategy, consisting, for example, of simply allocating one fifth of the portfolio to each of the five available options, can thus have dramatic consequences on the risk profile of the portfolio.

 

Organ donations
The fact that human choices depend heavily on the way options are presented has been documented in many areas. A notable example in the area of healthcare is organ donation. Indeed, donation rates tend to be significantly higher in countries with an “opt-out” system than in those with an “opt-in” system. An alternative approach which is likely to increase the rate of organ donation relative to an “opt-in” regime is that of an “active decision”: for example one could ask people if they consent (yes or no) when they renew their ID cards.

 

So what conclusions should we draw from these phenomena? Richard Thaler and his colleague and expert in constitutional law, Cass Sunstein, draw a positive and encouraging one: while fully safeguarding individual freedom of choice, a thoughtful presentation of the available options can “nudge” people to make choices that, through simple inertia, they would otherwise postpone.
 

 
Yves Nosbusch

Chief Economist

BGL BNP Paribas
 

Published in the Luxemburger Wort (in French) on August 2nd 2014
 

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