BDI Models and its Application to Retirement Savings

BDI Models and its Application to Retirement Savings Anand S. Rao Diamond Management & Technology Consultants SABE-2007 Presentation May 18, 2007

Contents

Inadequate Retirement Savings

Key Retirement Decisions & Barriers to Decision-Making

Goal-directed and Reactive Investment Planning (GRIP)

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

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

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

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

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

Contents

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 Enrollment Contribution Rate Asset Allocation Portfolio Re-Balancing Key Retirement Decisions Inertia to act Key Barriers to Decision Making Procrastination Lack 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?

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 Key Barriers Addressed 1 2 3 4 1 Procrastination 1 2 3 3 3 Inertia to act 1 2 3 4 4 4 Lack of self-control 2 4 3

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

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 Key Barriers Addressed 1 2 3 4 1 Inertia to act 1 3 Lack of self-control 2 4 3 1 Procrastination 1 3

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 SMarT TM participants

Contents

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

… .

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

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

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

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

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 Procrastination Inertia to act Key Barriers Addressed Lack of self-control 1 2 3 1 2 3 2 3 3 1 1 1 2 2 2 3

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