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The Actuary The magazine of the Institute & Faculty of Actuaries
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Making financial decisions

It’s easy to hypothesise that consumers should take all of the available information and make a logical, rational choice each time. However, there are lots of pressures that compromise this ideal. Consumers in general do not have access to complete information, they don’t have infallible powers of reasoning, they don’t have unlimited time, and they are open to persuasion, whether deliberately intended or otherwise.
During 20034, the actuarial profession commissioned some exploratory research to test whether the psychological factors that influence consumer choice in everyday situations also affect choices in the world of finance specifically in choosing a pension. We shall look at the results of this research a little later. First, it may help to set the scene by looking at some psychological results from another area of commerce, and discussing how these results have been used to influence consumer behaviour.

Supermarket sweep
Supermarkets are big business. Any sort of competitive advantage that one can gain over another could be the difference between survival and failure. Recognising the importance of consumer behaviour, a supermarket group employed psychological research tools and discovered two curious aspects. First, when people are shopping they usually look at the items that are at eye level first. They seldom cast their eyes to the top or bottom shelves. Second, when presented with a chequerboard patterned floor, people pushed their trolleys at a constant rate of squares per minute.
The usefulness of these bits of information is not immediately obvious. However, if you are the supermarket owner, and you take your own-brand goods and place them exclusively at eye level, you can start to see the benefit. If you also make the chequerboard pattern on the floor bigger on aisles that have staple goods like bread and milk, and smaller on aisles that have luxury goods, you engineer a longer stay in the luxury goods aisle. This increases the chance of a spur-of-the-moment sale in your most profitable area.
So, there are two steps to the process here: you have to find out what makes your consumers tick and then alter your behaviour or presentation to achieve the required change in consumer behaviour.

Forgive debtors
The financial services industry has had one resounding success in the last 10 years personal debt products. The headlines proclaim £1,000bn of personal debt in the UK. Why has there been this level of success? There are a number of reasons, some sociological, some psychological. People are more comfortable with debt now compared to the early 20th century when it was less socially acceptable. However, the debt providers and packagers have also employed a number of vital psychological tricks.
A familiar situation: you are making a number of large purchases at a store. At the checkout the assistant says: ‘You could save 20% if you take out a store card today, sir. That would be £60 off your shopping right now.’ This is top-drawer stuff. First, they have you in a vulnerable position; you are under time pressure to decide. Second, they are effectively saying ‘You’ll make a £60 loss if you don’t.’ In general people are loss-averse, so this strikes a chord. Third, people think short-term; they want jam today, never mind the consequences tomorrow.
With these psychological tricks being played so deftly, it is easy to forgive people for getting in over their heads. However, if we as a profession are to be effective in our social policy role, then we need to make sure that the same psychological techniques are available to reduce debt and increase saving.

Wine, sir?
The research the profession commissioned found a number of interesting results. The first result has been observed in many different experimental and real-life situations.
Imagine yourself in a restaurant with the wine list. What thought processes do you go through to decide on a wine? Generally there’s a bit of discussion on the colour, red, white, or for those who are already struggling to choose, rosé. If the list is extensive enough, ‘country’ may be your next filter. Eventually you narrow your choice down to a French red, perhaps from the Burgundy region. What next?
My guess is that you scan the prices and discard the cheapest one or two. After all you don’t want to offend your fellow diners, let alone the wine waiter. You then discard the most expensive ones, on the basis that your share of the £1,000bn personal debt mountain is high enough already, and choose one of the nice, middle-of-the-road bottles. If this doesn’t sound familiar, then your name must be Clarke, Goolden, or Abramovic.
Our research points to the same result when consumers are deciding on their level of savings. If presented with the choice of saving £25, £50, £75, or £100 a month, people gravitate towards the middle. However, if presented with an additional four choices, extending to £200, then the same people are drawn to a higher number. Obviously there is a limit here on how much the offered options can influence the final decision. This only works on the basis that the consumer is being presented with a reasonable set of options. However, the implication is that it is the relative rather than the absolute level of savings that people use as a deciding factor.
The researchers also found it possible to influence the answers made to questions at the end of the advice process by altering the presentation of earlier questions. In particular, subjects could be coerced into choosing to save higher amounts by showing examples of high contributions earlier in the process. This has important consequences, as clients may use general discussions with advisors as cues that influence their final decision. How this process can be monitored and regulated needs careful thought.
The same central bunching feature is seen in investment choices, although here there are few absolutes for financial consumers to draw upon. While it is obvious that someone on the minimum wage cannot afford to save £1,000 a month, there is no externally applied limit to the proportion of their savings invested in equities. So, when presented with equity proportions of 0%, 30%, or 60%, the middle will dominate. This has implications for Sandler-type products that have a maximum equity exposure of 60%. If this limit is meant to represent some sort of ‘ideal’ for the average consumer, then presenting the choices as above could have the unfortunate effect of halving the actual equity proportion achieved.

Graphic detail
To gauge consumers’ understanding of investment risk, and their attitudes towards such risk, the research asked respondents to evaluate 22 presentations of risk. Some of these presentations were descriptive, some were statistical, framed in terms of percentiles, and one showed a probability distribution as a graph.
The various presentations were ranked according to their usefulness, ability to be understood, and their suitability. Interestingly the highest-scoring presentation overall was one that set out the 5th, 50th, and 95th percentile results, with the next highest being the graphical presentation tied for score with a seemingly bland statement that there was a 90% chance of getting back at least as much as was invested.
This last result is interesting in itself, as it points towards another result discovered in previous research studies: consumers are loss-averse. If an option offers a chance of making a loss then there has to be, in general, a chance of making a gain that is twice as high. That is, losses are weighted twice as much as gains by consumers.
The fact that a graphical presentation had a second-equal score suggests the current strategy of bombarding financial consumers with more and more numbers is potentially flawed.

Mañana, mañana
The form of presentation is important as is the timeframe over which the recipient of advice must act. Although in financial terms it is better to start saving sooner rather than later, the research shows that people are more likely to commit to a savings plan that starts after a period of elapsed time. This gives time to adjust to the idea, rather than losing disposable income immediately.
Obviously this approach only works if there is a definite commitment to save and that commitment is on the basis of ‘buy now, start paying premiums later’. Without this commitment tomorrow may never come.
Timing is also important when keeping track of savings. If a relatively high equity content is appropriate for an individual’s savings plan, less frequent updates may be beneficial in keeping them on this course. Loss aversion tends to cause panic selling of volatile assets when markets fall below some perceived threshold when in many cases hanging on for the long term is the best course of action.

Industrial revolution
The financial industry in the UK has been dominated by a distribution model with advice at its heart. This advice has been geared towards intelligent, logical, financially aware consumers, acting rationally, and in their own best interests. However, the results of our research and of previous similar research suggest people simply don’t act this way. Consumers find it easiest to decide when provided with simple, relevant, and relative choices.
Rather than more information, less information appears to be the key. However, this information has to be presented correctly and the content has to be tailored to the individual in question. With initiatives in the UK to move towards more self-service, reduced-advice channels, there will be a requirement for even more clarity of presentation.
Surely the way forward is education? Well, education is important, I’m sure we would all agree. But the research suggests that, in situations that occur infrequently such as making important financial decisions, education has limited effect. There aren’t enough opportunities and these opportunities don’t come round quickly enough for us to learn the lessons required. How many people jumped out of the equity market at its lowest point and into the property market as it reached its peak?
We have shared the results of our research with HMT, industry bodies, and the FSA. In particular we have included the results of our research in representations on the FSA’s consultation on projections and have taken the opportunity of meetings with John Tiner and Dan Waters to discuss our results so far. As a profession we have limited scope to change the financial industry in the UK directly, but in partnership with external bodies we hope to advance our social policy aims.

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