ProtectionFeb 13 2013

Trust in behavioural economics pays off

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As many as 77 per cent see their savings as a way to fund pleasurable activities and possessions against 70 per cent who see their savings (not their insurance) as a way to provide financial security, particularly in the current economic climate 49 per cent of the sample agreed with the statement “despite recent welfare cuts I believe the welfare state will always provide a safety net for me in times of long-term sickness, unemployment or disability.”

A large number of consumers clearly feel that the best way to deal with the financial problems they face is to forget them. Research has discovered two contrasting approaches to the pressures people face: ‘lotus eaters’, whose strategy is to forget their problems and ‘loyalists’, who believe that the welfare state will always provide in times of need.

The public seem to have imposed a fairly commonly agreed price ceiling of £20 a month on individual insurance purchases regardless of sex, age or region. With the exception of those buying private medical insurance, there appears to be a limit to what people are prepared to pay for insurance products.

There is a reaction by some in the industry who treat answers like this as if they have been supplied by irrational idiots. A ‘casino mentality’ has been identified in some studies, which some have perceived as a condemnation of the public’s attitude, but I see as an extension of the sort of economic behaviour we detect when looking at protection.

Understanding behavioural economics helps us to realise why these answers are given. Take the ‘optimism bias’, a 2012 study authored by Dr Talia Sharot. She observes: “Both neuroscience and social science suggest that we are more optimistic than realistic. On average, we expect things to turn out better than they wind up being. People hugely underestimate their chances of getting divorced, losing their job or being diagnosed with cancer; and overestimate their likely life span (sometimes by 20 years or more). The belief that the future will be much better than the past and present is known as the optimism bias.”

This degree of optimism helps to explain why people do not perceive the need to buy protection as a priority. To take another example, a ‘trust-deficit’ has also been observed, which has increased alongside the lamentable outcry around PPI. I suspect the size of this awful scandal will probably never be known. But very few people have been untouched by it – or the fallout from it. That erodes confidence and persuades people to find other priorities.

Another influence is ‘hyperbolic discounting’, which Alan Newman, a leading thinker on behavioural economics in our industry, described as: “If something’s likely to happen a long way off in the future (that is more than three years) – we discount it much more than we should.”

Open University psychologist Mark Fenton O’Creevy, throws more light on the ‘casino mentality’: “Think about how people get into financial trouble. A person told their credit card is about to be taken away because of serious debt, cheers themselves up with a spending spree while they’ve still got it. They know this will put further strain on their parlous finances, but shopping is their way of dealing with the stress of debt.”

Our reaction to this can be uncertain. Hannover Life Re and our team at the Protection Review pondered the results for a long time. Living with protection and believing in its value so much it is easy to blind oneself to the fact that people need persuading to trust us. No, their behaviour may not be logical but it is understandable and we need to feel their conflict and uncertainty and to find ways that behavioural science shows us can help them to understand our proposition better. Framing the cost of a protection policy in terms of what they might give up as an alternative helps them to evaluate their priorities better. “For the cost of five pints a month you can buy ££ of cover for your family”. We are presenting them with choices and challenges. But is that not what life is about anyway?

Peter Le Beau is co founder of the Income Protection Taskforce

Key points

Behavioural economic theory helps us to understand how people think about money and how they see their futures.

A degree of optimism helps to explain why people do not perceive the need to buy protection as a priority.

Another influence on our thinking is hyperbolic discounting.