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Symposium 2012

Proposal - Reinventing Financial Literacy after the Global Financial Crisis

The Challenge

As governments face increasing debt burdens and companies too face significant cost burdens, there is a clear movement towards individual responsibility for financial planning for retirement. This mov ...

As governments face increasing debt burdens and companies too face significant cost burdens, there is a clear movement towards individual responsibility for financial planning for retirement. This movement is happening at precisely the time that individuals themselves are feeling more insecure about the future in the face of declining job security and the increased reluctance of financial institutions to provide credit.

The following solution proposals are an excerpt from the background paper “Financial Literacy: Viewpoint”.

Need to refocus financial literacy programs after global financial crisis

Future financial literacy programs need to prepare participants for three broad realities of life after global financial crisis – government bonds can no longer be considered the safest investment option, healthcare costs will rise at a higher rate in the next decade and it will be accompanied by generally higher inflation (due to rise in fuel and food prices). Keeping these in mind, financial literacy programs need to focus on helping people do better risk management of their savings through portfolio allocation, retirement timing, purchase of annuities and draw-down strategies.

Many financial literacy programs do not create awareness about insurance coverage (Tennyson, 2011) and a large proportion of insurance purchasers do not understand risk-return relationships. Ability to choose appropriate insurance cover is very important in managing health care costs. Till now there is no survey to find out if people understand the difference between co-pay and co-insurance or how they choose their deductibles in High Deductible health Plan ( HDHP). Some research on consumer behavior has shown that people usually prefer low deductibles. It is possible that this may not be the best choice for them.

Annuities play an important role in mitigating longevity risk in retirement, yet their penetration remains low (Brown, 2009). Again there is not much evidence about the impact of financial literacy on annuity demand, but it has been proven that financially literate individuals are more likely to choose annuities (Brown, Casey, and Mitchell, 2008). Annuity purchases have also been found to be significantly affected by negative framing effects (Agnew et. al., 2008). Therefore, it is important that financial literacy modules include information about annuities and educate investors on how to take decisions looking through the negative framing effects.

Broadly financial literacy programs need to find a balance between imparting basic numeracy (like ability to calculate compound interest rate, real returns, etc), understanding of basic financial concepts and how various products work and financial entities (like pension funds, mutual funds, insurance companies) work. Most importantly financial literacy programs need to ensure that participants become informed consumer of financial information.

Innovations in financial literacy

In last few years, there have been many innovations in education that are being applied to financial education. These innovations use the basic tenets of behavioral economics and new technology which makes the process of financial education engaging and impactful.

  • Better visualizations – Reading materials whether online or in form of print communication can be tedious to follow and boring. People find pictures and videos more captivating than textbook style teaching. New age financial literacy programs use videos and story-telling in their messages to tell a more personalized story. For example, Practical Money Skills for Life has created a comic book where The Avengers teach saving skills in form of a story (Practical Money Skills for Life, n.d.).
  • Educational games to impart financial education - Gaming is being increasingly used to educate individuals about basic financial concepts. There are games like Countdown to Retirement, Financial Football, Financial Soccer, Money Metropolis, Ed’s Bank etc, to teach individuals about basic financial concepts. Using network effects to spread financial literacy – people are usually influenced by their peer group for activities they participate in. (Gine, Karlan, and Ngatia, 2011) show that financial literacy materials are likely to have a larger positive impact when financial literacy materials were distributed to a peer group located closer to each other than a peer group loosely connected. It has been proved that social networks increase the chances of purchasing insurance (Cai, 2012). The network effects actually work through knowledge diffusion rather than imitation or informal risk sharing.
  • Independent financial advisors – It has been found that many people are distrustful of financial advisors that are affiliated to financial institutions (Calcagno and Monticone, 2011). Therefore for successful financial literacy programs, it is important for various organizations responsible for financial literacy work with independent agencies.
  • Tools for decision making – lastly, individual planners need access to tools for making savings decisions. An example is ESPlanner (n.d.), a financial planning tool allows individuals to create lifetime financial plans and helps plan for life events.

 

In order to ensure that financial literacy programs have a positive impact on saving behavior, it is important to ensure that measurable performance indicators are set up and benchmarked against. It is also important to ensure some individual accountability. Finally, it is important to realize that different solutions work for different population groups, so there should be multiple ways to approach financial education and there is no single solution for their entire population.

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