Tag Archives: behavioral economics

Why Buying Insurance Is Like Dieting

Have you heard of the marshmallow test? A marshmallow is placed in front of a kindergarten child, and an offer is made; you can eat this marshmallow right now, or, if can wait for 15 minutes, you will get a second one. This experiment, which sounds quite simple, provides invaluable insights about the self-control dynamics of humans.

The experiment was conducted first in 1960, and the results have been evaluated over the years. It was found that kids who were able to hold off a long time without eating a marshmallow were more likely to have higher SAT scores. Similarly, in their adulthood, these people had a better body mass index, more self-confidence and less tendency to be addicted.

Studies also show that delaying gratification gets harder under stress and keeps getting harder, the longer you delay. If you realize that you forgot your entrance card after driving in terrible traffic in the morning, you will be defenseless against dessert at lunch.

Buying insurance is an act of delaying gratification, like retirement saving, dieting or avoiding sugar. It takes real self-control to spend your money on a product that you don’t enjoy when it is not mandatory. Delaying today’s pleasure for a possible future benefit, buying car insurance instead of a new phone….

So, if buying insurance is an act of delaying gratification, how can you help your customers on this issue?

See also: Is Buying Insurance Like Ordering Food?  

Develop Desired Products

Perhaps be a supporter on good days rather than just compensate for the bad days? Why don’t life insurance companies try to make their customers’ life happier? At least they could send them a cake on customers’ birthdays.

Enriching an insurance product with benefits that can be used immediately can also help customers to delay gratification. Offering free car washing service once a month to your car insurance customers will definitely make them more satisfied with their purchase.

Ease Purchasing

Did you know that we suffer physical pain when making any payment? Neurofinance studies show that spending money activates the areas of the brain associated with physical pain and feelings of disgust. And the activation is much more when payment is in full view. Ask your customers to pay in cash, if you want to make your customer suffer. PayPal, mobile wallets and contactless payment are much kinder solutions.

Know Your Best Customer

The best insurance customers are those people who make regular savings, eat healthily and do volunteer jobs for the community. Why? Because those people have enough self-control to delay daily pleasures. As they are aware of their responsibilities, they will be more likely to purchase insurance. They will also do their best to avoid risks. Identify this customer segment and flag them as the best customers.

Appreciate the Will

Being appreciated strengthens our will, motivating us to be more responsible. Insurance companies should appreciate their customers both emotionally and financially.

The health insurance company that appreciates customers with emails for being careful about pursuing a healthy life would increase customer satisfaction. The insurance company that gives small gifts to customers who have not any claim for years would likewise be rewarded with customer loyalty.

Knock on the Door at the Right Time

High stress leads people to instant gratification. Long-term plans are usually made in quiet moments. If you are not able to check the pulse of your customers by using a wearable device data for now, don’t worry. Just call your customer in the morning instead of evening after a busy work day. Speech emotion recognition systems are also powerful tool that should be used in call centers.

See also: The Behavioral Science on Buying Insurance  

Automate Decisions

Delaying gratification is a real struggle when you do it the first time. We struggle mentally, but it becomes easier the next time, and finally it turns into a kind of habit. Our brain automates the action, so we don’t have to spend our self-control power.

It is difficult to get consumers to adopt the insurance purchasing habit, so there is bloody competition for the customers who already have this habit. Customer acquisition is silver, but retention is golden.

Insurers rely on insurtechs for the technological transformation of the industry. But first the industry needs a customer-oriented transformation. This may be possible by understanding the emotional and behavioral tendencies of consumers.

Thanks to Walter Mischel, who inspired this article with research for more than 50 years on delay of gratification and self-control.

The Behavioral Science on Buying Insurance

Why do people buy insurance, when they could spend their money on dozens of other excellent products and services? A classical answer would be, “to be safe against risks.” Then, why do some people spend thousands of dollars on insurance products while others don’t spend a penny? Doesn’t everyone want to be safe against risks?

To find real answers, it is necessary to take a closer look at the motivations of people.

Deciding whether to purchase insurance is not easy. Consumers usually don’t get any financial benefit in return for the premium they pay. However, in addition to financial benefits, insurance products offer moral benefits such as peace of mind and a feeling of safety. So the benefit of insurance from the customer’s view can be formulated as (risk expectation x coverage) + (moral benefit).

Thus, the motivation of customers to buy insurance depends on two main indicators: risk expectation and risk sensitivity. Risk expectation determines the expected financial value of insurance. Risk sensitivity shows the concerns of customers, so it directly affects moral benefit.

Who Wants Pizza?

Being cautious is the main instinct behind insurance purchases. Of two consumers who face the same risks, the more cautious one is more likely to buy insurance. Exercising regularly to be safe against chronic illness resembles buying home insurance to be safe against fire, theft and earthquake. Preferring fast food instead of healthy food is like buying a great TV instead of auto insurance. Purchasing an insurance product is like dieting; costs arise immediately, but benefits are achieved later.

See also: Behavioral Economics Show Details Matter  

Generally, competition among insurance companies is thought to depend on prices, brand awareness and customer service. In fact, competition is much broader. Purchasing decisions cross product categories; people buy home insurance or… shoes.

Insurance companies should develop strategies to convince more people to buy insurance, not those shoes.

Fans of Insurance

The key point is: People make risk assessments based on their personal experiences, not actuarial tables. Therefore, insurance companies need to focus on the feelings and emotions of consumers and not just working on statistics.

People exaggerate the likelihood of risk occurrence under certain circumstances, which increases their sensitivity of risk. People will be more likely to buy insurance even if all other factors are the same.

Some opportunities:

  • High Loss Frequency: Consumer tend to demand insurance where loss frequency is high even if severity is not so great. A house fire is a disaster, but a car accident is more likely. This explains why automobile insurance is one of the biggest lines.
  • Customers With Claim: Risk sensitivity increases cumulatively. If you faced a negative situation recently, you look at the world more pessimistically. It would be a good strategy to offer home insurance to customers who made auto insurance claims the previous month.
  • Highlighted Risks: If a risk is highlighted in public, people exaggerate the possibility even if risk occurrence is not high. Theft news broadcast on TV for a week would increase people’s tendency to buy home insurance policy for a time.
  • After Tragic Events: Right after tragic events like earthquake, flood and terror attacks, people think they will happen again soon. It makes no sense to buy insurance after an earthquake because, statistically, a new earthquake is not to be expected soon, but sales rise.
  • Uncertainty and Fear: Important experiences like having a baby or suffering a heart attack make an impact on people’s view of life. There will be a significant increase in risk sensitivity. Therefore, it would be a good strategy to offer life insurance bundled with family health insurance to a customer who had a baby recently.

Homework for Insurers

On the behavioral approach side, there are some basic steps to follow to grow the whole insurance market;

  • Being Micro: Insurance products are not only complex but also are too focused on macro risks. In fact, the daily risks of our lives are more micro and ordinary. Why are major risks like fire or flood pointed out in home insurance products rather than damage to electronic devices or accidental risks?
  • Being Visible: Insurance companies have a natural advantage because they pay thousand of claims every single day to people and touch their lives. Creating positive stories from negative events can bring life to insurance products.
  • Being Informative: Insurers should undertake the mission of “warning against risks,” in addition to providing financial coverage. The insurance company that interacts with customers regularly and improves their risk awareness would build brand trust.
  • Being Protective: Getting share from competitors is becoming tougher everyday. Insurance companies are not only competing with new-generation insurtechs but also with technology, entertainment and consumer goods companies. The most rational and cost-effective strategy could be retaining the existing customer portfolio.

See also: Machine Learning – Art or Science?  

New-generation economic theories based on behavioral science provide important insights about customers’ decision mechanisms. Many organizations, from e-commerce companies to government institutions, are profiting from the insights. For insurance companies, a good place to state would be understanding that customers are not robots who just want the most coverage at the cheapest price.

Thanks to Daniel Kahneman and Richard Thaler for inspiring this article with their behavioral economic theories.

Behavioral Economics Show Details Matter

Small changes can sometimes have a big impact. This is particularly true in the realm of behavioral economics. At its core, behavioral economics (BE) challenge the traditional economic theory that individuals are sound and rational (“slow”) thinkers, by asserting that we instead rely more on heuristics — or mental shortcuts — to make quick judgments. Using comprehensive experiments, BE allows us to test ways to encourage individuals to “slow down” this fast processing through simple redesign and rewording.

When BE techniques are applied to insurance applications, small changes in the way that questions are designed and worded can lead to more thoughtful completion by the individual. This, in turn, encourages an increased disclosure of medical conditions, resulting in a more comprehensive view of the individual’s health. Ultimately, this additional information and clarity can help the underwriting process, mortality and morbidity results and company profitability.

Gen Re was at the forefront of this research for the insurance industry, conducting a BE study related to individual life insurance applications in 2016. This study successfully determined several BE approaches to enhance an application and increase disclosure rates simply through changes in question design and layout.

Traditionally, the insurance industry has relied on a more tried-and-true approach to application design. For individual life, companies widely use standardized application questions relating to medical conditions.

See also: Making Life Insurance Personal  

In 2018, Gen Re set up a new BE experiment to take another look at designs from the 2016 study and to assess the effectiveness of a standardized question design in encouraging medical condition disclosure. This study used standard questions as a control group, testing them against various “treatments,” or different ways of designing the application questions. A sampling of U.S. residents, ages 30-60, was asked to complete online life insurance application questions. Close to 2,500 online applications were completed. Overall, six different question designs (treatments) were tested across 12 medical conditions. The objectives of the study were:

    • Primary: Understand how we can apply insights from behavioral science to increase an applicant’s disclosure level for insurance
    • Secondary: Determine how long it takes an applicant to complete the various treatments, so we can better assess answers to the question, “What is the best combination of time and experience of completing, versus understanding and overload?”

The results strongly supported what was found to be most effective in Gen Re’s 2016 BE study: a five-point scale question design (see Exhibit A). The multiple-choice options on the five-point scale prompt respondents to think about each medical condition, increasing their chance of remembering whether they have ever been diagnosed. Moreover, the clear definitions for each option eliminate the uncertainty respondents may have about whether they qualify as “having” the medical condition.

Exhibit A: 5-Point Scale

Have you ever been diagnosed, treated, tested positive for or been given medical advice by a member of the medical profession for a disease or disorder such as:

In comparison, the standardized questions used as the control group were open-ended and asked individuals whether they had ever been diagnosed, treated, tested positive for or been given advice by a member of the medical profession for a particular medical condition (for example, “Any cancer, tumor, cyst or nodule” for cancer-related conditions). This may require a level of medical knowledge beyond what can reasonably be expected of someone who is not a medical professional and can create some uncertainty or difficulty in recollection for individuals completing the application.

In addition, although the five-point-scale questions were one of the longest in terms of respondent time to complete — averaging almost eight minutes – condition disclosure increased by four to eight times over the standardized (control) questions.

The standardized question format was the shortest for respondents to complete, averaging just 2.34 minutes, yet it was found to be the least effective question design in terms of increasing medical condition disclosure.

See also: Digital Distribution in Life Insurance  

By implementing a new design framework, insurance carriers can improve not only the clarity of the application questions but also the level of information that is disclosed by applicants. While companies have much to consider when making changes to their applications, the results of Gen Re’s BE experiments show that small changes can have a big impact.

In addition to our leading behavioral economics research, Gen Re also conducts numerous studies that benefit the U.S. Group and Individual Life/Health insurance industry. Our wide variety of industry studies, and our MarketChecks on key topics of interest, keep us at the forefront of insurance research.

If you are interested in learning more about our research capabilities, contact me.

You can find the article originally published here.

Reprinted with permission from Gen Re. ©2019 General Re Life Corporation

Lemonade: Interview With CEO

Lemonade is currently the most talked-about disruptor. That’s why we’re pleased that, for the first time in Europe, Lemonade will present at DIA Munich what the pioneering concept is all about in a keynote presentation. As a special DIA Munich appetizer, we spoke to Lemonade CEO and co-founder Daniel Schreiber recently, exactly one year after the company launched.

DIA: Daniel, congratulations on Lemonade’s first anniversary. It must have been a roller coaster ride. Thanks for being willing to share some of the experiences and learnings. Did the first year meet your expectations?

Daniel: “Yes, it has been quite a ride. But it is great to see that we’re striking the right chord. We already sold ten thousands of policies. Our portfolio doubles every 10 weeks.”

DIA: If you had to name just one thing, what would you say is the key success factor so far?

Daniel: “Our renters insurance is 80% cheaper than what competitors offer and takes less than 90 seconds to purchase.”

DIA: 80% cheaper is almost unbelievable …

Daniel: “Many industry insiders think so, too. [They think that] at least 40% of what insurance carriers receive in premiums is paid out in claims. So if Lemonade is 80% cheaper it must lose money on every policy. That is not true. Renters insurance covers personal property, not real estate. The expected loss is therefore significantly lower and so should the corresponding premium be. Unfortunately, the enormous overheads incumbents have make low-premium products impossible. Their minimum premium reflects their high costs rather than your low claims.”

See also: Lemonade’s New Push: Zero Everything  

DIA: We can imagine that such a price difference attracts a specific segment …

Daniel: “Yes, indeed. We offer a good price, especially at entry levels. No less than 87% of our customers are first-time buyers. Lemonade is the preferred insurance brand among first-time insurance buyers. In the state of New York, where we first launched Lemonade, we now have a market share of 27% among first-time buyers.”

DIA: Was this the target segment you planned to focus on initially?

Daniel: “Not really, at least not to this extent. This was definitely not planned or expected. It appears our proposition is attracting people who did not think of such an insurance before; because it was too expensive, too much hassle, or because they had little trust in the added value. So it turns out we actually opened up an underserved, untapped market. This was really a surprise for us, as well. It just shows that with really new propositions there is only so much that you can plan.”

DIA: This suggests the Lemonade concept is about solving frictions that customers experience when dealing with a traditional insurance incumbent. Aren’t you selling yourself short here?

Daniel: “True. It is not just about solving frictions; being faster, better or cheaper. That wouldn’t be sufficient in the long run. When we started conceiving Lemonade, we immediately realized there is no way you can beat insurers at their own game. We needed to think beyond that. We decided to foster trust, not suspicion. Our business model is built on two very distinctive pillars: behavioral economics and artificial intelligence.”

DIA: The pillar that is often highlighted is behavioral economics, one of the reasons we like Lemonade so much. Insurers could benefit much more from psychology and social sciences.

Daniel: “The vast knowledge and experience of our Chief Behavioral Officer Dan Ariely (professor of psychology and behavioral economics at Duke University) is instrumental in this. We apply behavioral economics to neutralize the adversarial relationship, the conflict of interest, between customers and their insurance provider. We take 20%, and the rest (80%) goes to paying claims, and this includes our reinsurance. If less than the 80% is used to pay out claims, for instance 75%, the 5% unclaimed money is donated to charities chosen by customers. The maximum amount that can be given back is 40%. Lemonade gains nothing by refusing a claim. This way we are reinventing insurance from a necessary evil to a social good.”

DIA: Can you explain how behavioral economics reflects in Lemonade’s daily customer experience?

Daniel: “Not just our business model but also the whole product flow is informed by behavioral economics. For example, we ask people to sign on the top of the form, not at the bottom. Behavioral research shows that asking people to pledge honesty first results in forms that are actually more accurate.”

DIA: How does this affect the combined ratio?

Daniel: “Multiple ways. For example, we also apply behavioral economics to reduce fraud. In the onboarding process, customers are asked which charity they want the money that is not used for claims to go to, let’s say the Red Cross. Now, when at some point in time a customer files a claim, we first remind the customer of the charity he or she selected before diving into the claim. We do that on purpose. To many people, insurance fraud is considered a victimless crime; you’re not really hurting someone, at least that is the perception. Research shows that 24% say it’s okay to pad an insurance claim. We’re changing that by immediately creating the presence of a victim. Making it crystal clear that a claim harms a charity someone cares about inhibits misuse.”

DIA: Do you already have proof points that using behavioral economics this way works at a larger scale?

Daniel: “Obviously we’re a young company, so the amount of claims that we receive are still limited. But we already have early indications that this really works. In the last two months, we actually had six customers who claimed and got paid, but later on returned the money. Someone, for instance, thought his laptop was stolen, claimed and got paid. A few weeks later, it turned out he had left the laptop with his mother-in-law. He then decided to return the money, probably because he didn’t want to harm the charity he selected. I would really love to know how many customers of traditional insurers are returning their money.”

DIA: Insurers need to manage the feelings side of financial services much better than they do today. Quite a few tend to forget that when they are going digital. Others are building hybrid solutions of, for instance, chatbots and human experts. How do you secure the human side in a pure play such as Lemonade?

Daniel: “Behavioral economics is one pillar of our business model; artificial intelligence is the other. Thanks to AI, we don’t have to rely on brokers and paperwork. Underwriting and claims handling are taken care of by AI, as well. This makes it even more important to secure that we are recognized as living, breathing people who really care. My co-founder Shai Wininger has a rare talent to marry technology with customer understanding. Our bot has a name. It talks in an approachable manner. It doesn’t say, ‘I don’t understand.’ We know its limits and anticipate the direction in which the conversation is going. Next-level questions are seamlessly moved to our, human, support staff.”

See also: Lemonade: World’s First Live Policy  

DIA: We quite often see that traditional insurance carriers have a strong immune system when it comes to embracing insurtechs. Apparently, different cultures are difficult to match. Sometimes we even see organ rejection. We noticed that the Lemonade team not only incudes tech veterans like yourself but also former executives from AIG and ACE. How do you make that work?

Daniel: “When we started thinking about a new concept in insurance, we just had a rudimental understanding of insurance. We had the advantage of being ignorant. We had no preconceived notion. This helped us to question the basic principles of the industry, such as the conflict of interest.

“Coming from the outside helped us to rethink, reconceptualize in a fundamental way, from scratch, what Lemonade should be about.

“Now, it is only so far you can take that. As soon as you move to execution, you really need to have deeply entrenched insurance knowledge on board. Think of the regulatory maze we have to go through. Then it comes to finding the right people, which was not that easy. We soon realized that we were looking for ‘insiders’ who were ‘outsiders’ at the same time. In our recruitment ad, we actually said it was a requirement to be in the throes of a midlife crisis; not feeling happy in the corner office anymore. They had to buy into our vision.”

DIA: We noticed that your fast growth in an market segment that is so difficult to reach by incumbents has led companies such as GEICO and Liberty Mutual to use “lemonade” in their marketing and promotion activities …

Daniel: “Ha ha, yes, we’ve noticed that as well, of course. GEICO even introduced a ‘lemonade’ TV commercial at the same time as we launched the company. Liberty Mutual, in fact, introduced a new brand, Lulo, and paraphrased everything, from logo to pricing.

“We take it as a compliment that such renowned brands are looking at us, and try to learn and use our ideas. But the examples also show that it is not that easy. Lemonade is more than a logo. You really need to understand the two pillars of our model: behavioral economics and artificial intelligence and how that reflects in the way we operate. And you need to understand that we are really a different kind of company. Obviously, we have duties to our customers, employees and investors. But we’re also a B-Corp, which makes us legally committed to social impact. Our customer base is therefore more like a community of people around a cause – which in turn results in more trust and less fraud. It is about aligning customers and insurer, and giving up underwriting profits. We’re rebranding the insurance sector.”

Where Can You Find Growth (Part 2)?

We are continuing our two-part series on where leaders should focus for growth in a changing world that is full of new technology. This post builds on Part One, which covered major trends, the need for customer insight and what is required to manage your data effectively.

Our attention turns again to your customers — but this time also considering the issue of their irrational behavioral biases. How should this human trait influence your plans or focus for growth?

With irrational customers, what should you do?

With the Financial Conduct Authority (FCA) focused on behavioral economics (BE) and expecting providers to take it into account, the days of assuming customers will act rationally are numbered.

I’m sure most of you have at least heard of BE. The success of popular books on the subject — from the easy to read “Nudge” to the slightly more challenging “Thinking Fast and Slow” have ensured that there has been plenty of media coverage and social media debate on the implications and appropriateness for policy and action.

See also: How to Take a Bold Approach to Growth  

As with many academic disciplines, different experts use slightly different nomenclature to order the different irrational behavior or biases observed. However, for financial services clients, a good place to start is the list of 10 biases published by the FCA. My own experience in helping clients test communications or design marketing to take irrational biases into account suggests this list covers the bases.

Do you test your communications?

Of course, the focus of FCA regulatory action is ensuring the customers receive positive outcomes through products and services suitable for their needs. Unfortunately, some agencies offer to help businesses understand and act to protect customers from BE biases by seeking to “rubbish” traditional research or the role of customer insight teams. This is so misguided. Most successful BE projects require well-designed research, as well as behavioral analysis, data capture and database marketing skills in experimental design. In other words, it is probably your existing customer insight team that is in best place to take such work forward.

Given that most firms focus first on ensuring their communications could not be accused of manipulating biases, two biases (in particular) are worth considering:

  • Framing, salience and limited attention: Is the bias such that different decisions are made if information is presented/structured differently (as sommeliers know well).
  • Present bias: Is the present over-valued compared with the future (i.e., I would accept a smaller payout now, compared with delayed gratification with better return).

Still, other biases matter and occur from time to time. For a fuller list, see this previous post summarizing all 10 biases.

Conclusion

There are many different and exciting innovations happening, including the use of blockchain, robotics, virtual reality and machine learning. But, having seen those innovators who go on to thrive and those who do not, I am making the case to focus on people — not technology.

Developing a strong customer insight capability that is supported by well-managed data and is used to guide all interactions with customers is a sustainable route to growth. However, to achieve both customer loyalty and the approval of regulators, you will also need to consider irrational customers.

We are practically in a “seller beware” market, so, to truly protect your business, make sure you know (better than your competitors) how to help your customers achieve positive outcomes. Oh, and learn how to tell them what you know in their language.

See also: Does Your Culture Embrace Innovation?  

Such a human-centered-design approach to business is not easy, but it is fulfilling. Focus on understanding and serving your customer better. When you have a compelling story to tell, you will also be able to mobilize one of your biggest weapons. That, of course, is all the people who work in your business.

To modify the oft-quoted line by President Bill Clinton about what matters most: “It’s the people, stupid.”