This study examines the saving and insurance behavior of 386 Boston University employees who volunteered to receive financial planning based on ESPlanner (Economic Security Planner) - a detailed life-cycle financial planning model developed by Economic Security Planning, Inc. Because the employees received their own financial plan, they had a strong incentive to provide full and accurate financial information. Hence, the data appear to be of particularly high quality for studying saving and life insurance decisions.
ESPlanner recommends annual levels of consumption, saving, and life insurance holdings that smooth a household’s living standard through time subject to the household not exceeding its self-ascribed borrowing limit. The program treats housing and special expenditures as "off- the-top, " adjusts for economies in shared living and the relative costs of raising children, makes highly detailed tax and Social Security benefit calculations, and permits users who don’t want a stable living standard to specify how they’d like their living standard to change through time.
The findings are striking. First, the correlation between ESPlanner’s saving and insurance prescriptions and the actual decisions being made by BU employees is very weak in the case of saving, and essentially zero in the case of life insurance. Many employees are spending far more and saving far less than they should, while others are under-spending and over-saving. The same holds for life insurance. The degree of under-insurance seems particularly acute. Almost 13 percent of those BU spouses who are secondary earners would experience a 40 percent or greater drop in their living standards were their spouses to pass away in the near future. Another 13 percent would experience a 20 to 40 percent drop. Second, planning shortcomings are as common among high-income professors with significant financial knowledge as they are among low-income staff with limited financial knowledge.
Third, two thirds of BU employees are not in a position to smooth their living standards without exceeding their debt limits. Borrowing constraints are not only ubiquitous; they are also significant. Consider, for example, the University’s 403(b) plan, participation in which imposes borrowing constraints on almost two thirds of sample households. If this plan was eliminated and workers were directly paid what the University would otherwise be contributing to their 403(b) accounts, current consumption of married and single households would, on average, rise by 9.0 and 20.4 percent, respectively. And consumption at retirement would fall, on average, by 8.0 percent and 10.4 percent, respectively.
Fourth, although it limits the current spending of sample households, participation in defined contribution plans significantly lowers their lifetime taxes and raises their lifetime spending. Among married households, eliminating on a compensated basis, all defined contribution plans would, on average, raise our sample’s married couples’ lifetime taxes by 4.5 percent and their lower lifetime spending by 1.7 percent. For singles, the comparable figures are 6.1 percent and 2.2 percent.
