Background: We recently learned the sad news of Dr. Daniel Kahneman's passing at the age of 90. He was a pioneer in behavioral economics, receiving a Nobel Prize in 2002 for his ”prospect theory,” also known as loss aversion. The theory of loss aversion shifted my perspective away from the belief that employees participating in a DC plan often exhibit irrational behavior.

When examining employee behavior towards DC enrollment, many employers are puzzled by employees, particularly younger generations, who opt out of receiving free guaranteed money in the form of a DC match. Their conclusion is often that their employees are behaving irrationally. This viewpoint represents the supply side of the DC industry. However, from the employees’ perspective, deferring income today for a potential benefit gain in the distant future may run counter to their psychological tendencies. Kahneman’s “prospect theory” helps us understand and offers insights into this phenomenon.

Findings: To evaluate whether something is perceived as a gain or a loss, a reference or neutral point is essential, against which all outcomes can be measured. For employees, this reference point is often their take-home pay before enrolling in a DC plan. Upon learning about the DC plan, the employee may view contributions as losses relative to their take-home reference point.

Why is this the case? Kahneman explains that the pain of a loss has more than twice the psychological impact as the joy derived from a gain of an equal amount (which is loss aversion). Consequently, if the match offered is less than 100% of the contributed amount, the employee may perceive it as a potential loss and avoid participating due to loss aversion.

Bottom line: Kahneman’s research has led me to recognize that before we conclude certain behaviors are irrational, we should consider the possibility that these behaviors are rational in ways we haven’t yet perceived. Those interested in learning more about his work may want to read his best-selling book, “Thinking, Fast and Slow.”