Imagine a world where every financial decision was made with cold, hard logic. No emotion, no bias – just numbers. The real world doesn’t operate that way. This is where behavioural economics come in. When it comes to life insurance, understanding the quirks of human behaviour can make all the difference to help you protect your future.
How behavioural economics fit into life insurance sales
It’s essential to recognise that you aren’t always rational in your decision-making, especially when it comes to something as emotionally charged as protecting yourself and your loved ones. People often make choices based on emotions, perceptions, and biases. By understanding these patterns, you can be better positioned to make financial decisions, and ultimately, ensure you are making choices that align with your long-term needs.
- Anchoring: The power of first impressions
Anchoring refers to our tendency to rely too heavily on the first piece of information we encounter when making decisions, regardless of its relevance. A well-known example is a study by Tversky and Kahneman, where participants were asked to estimate the number of African countries in the United Nations after being shown a random number on a wheel. The higher the random number, the higher their estimate, even though the two were unrelated.
You may anchor your thinking around an arbitrary amount of life cover, like R1 million, even when your real needs – like paying off a bond – require more. Advisers can counteract this by anchoring discussions around actual financial needs. Insurers should offer products that link cover to specific obligations, creating a more relevant reference point and moving away from an arbitrary starting point.
- Framing: It’s all about perspective
Framing affects how people interpret information depending on how it’s presented. For example, consumers prefer to buy milk labelled as “99% fat free” rather than “1% fat,” even though both statements have the same meaning.
Advisers can frame life cover as protecting a family’s lifestyle rather than as a lump sum pay-out. Insurers can support this by providing tools that highlight emotional needs, like funding a child’s education, rather than abstract amounts.
- Loss aversion: Protecting what you have
Loss aversion is the idea that people fear losses twice as much as they value gains. A well-known example comes from investment behaviour, where people hold on to losing stocks longer than they should, in the hope of avoiding a loss. This shows our instinct to protect what we already have, even though it may ultimately cost us.
Clients often place more value on the potential loss of a source of income rather than on gaining a random lump sum. By structuring life insurance benefits around a client’s income and expenses, insurers can tap into clients’ natural aversion to loss. This approach makes the value of life insurance more tangible, compared to offering a general, undifferentiated cover amount.
- Status quo bias: The comfort of inaction
Status quo bias explains why people tend to stick with their current situation, even if change would benefit them. For example, organ donation rates are much higher in countries where citizens are automatically opted in, compared to countries that require people to actively sign up. The default option becomes the path of least resistance.
Clients often avoid updating their cover, even as their needs change. Advisers can help clients by encouraging regular reviews of their policies. Product providers need to offer cover that is flexible and easy to change throughout a client’s lifetime, moving clients away from their default position without requiring drastic action.
- Mental accounting: Clients view money based on its source
Mental accounting is when people mentally separate their money into different “accounts” depending on its source or intended use. For example, it’s been shown that people treat a tax refund differently than their regular salary, even though both are simply money.
Clients may see life insurance premiums as a grudge purchase rather than as an important investment. Insurers can help shift this perception by developing products that link premiums to specific needs and expenses, for example, cover for your client’s children and household needs, that clients are familiar with, and would form part of their monthly budgeting. This helps clients view life insurance as a necessary part of their financial planning, and see the cover that they have as relevant and aligned to their needs, rather than just another expense.
Products that match clients’ needs are key to understanding behavioural economics in insurance
Products that adapt to life’s changes, clearly link coverage to specific financial needs, and simplify decision-making all cater to the natural biases that influence human behaviour. These products enable advisers to tap into behavioural insights and guide clients towards better decisions.
This article was first published on FA News on 1 October 2024 and is attributed to Clyde Parsons, Chief Innovation Officer at BrightRock.
Leave a Reply