How Does PFML Fit into the Picture of Benefits?
The challenge facing our industry I kept coming back to was this: the same percentage of US workers have Disability insurance (aka Income Protection) as they did 30 years ago.
There are a lot of good things happening with Disability insurance. The number of workers has been growing and disability outcomes have been improving. But more people need this protection and they just aren’t getting it. How can we find coverage for all of those workers who don’t have disability insurance?
Insurers have been trying to solve this for decades with no real success to speak of. This paper will talk about Behavioral Economics, and then see if we can apply it to this problem.
Economics and Psychology
The study of Economics has been around for a long time. As long as there were resources that humans wanted, and those resources weren’t infinite, the laws of supply and demand have been considered. Many point to Adam Smith as the father of modern economic thought. His opus, An Inquiry Into the Nature and Causes of the Wealth of Nations was released in 1776, and it ushered in an era of deep thinking about economics. While you can easily argue that more modern economists have improved on Smith’s work quite a lot, you do have to allow that Smith started a revolution of sorts. Economics became a noble pursuit, and a key tool of business and government.
Psychology as a study can be traced back to ancient civilizations – as soon as we questioned why someone behaved the way they did. Most historians claim that the modern field of psychology dates back to the mid 1800’s in Germany. This is when theories and studies were first documented to be academically performed on human behavior.
These two pursuits have brought society much in the way of learning about how things work – markets for economics and the mind for psychology. Yet it wasn’t until the 1970’s when Amos Tversky and Daniel Kahneman brought the two fields together. It was more formally built into a defined field of study in the 1980’s by Richard Thaler. In short, Behavioral Economics attempts to understand what economic decisions people make in the real world – and allows for irrational decision making. For a more thorough (and very readable) history of behavioral economics, check this out from the University of Chicago.
The Problem With Economics
I’m not sure there is a “problem” with Economic study, per se, but the field of Behavioral Economics does expose some flaws of standard economic thinking. Standard economics creates a really good framework for thinking about the world. More supply of a resource brings prices down. More demand for resources brings prices up. The resource could be tangible things like steel or carrots. Or it could be a financial instrument like mortgages or stocks. Or it could be workers and wages (right now, fewer workers is leading to higher wages). Through all markets, economic principles can help us understand why things happen, and maybe even offer forecasts about what will happen.
Yet that foundational framework often breaks down in the real world. People make irrational decisions. We don’t always make decisions in our self-interest. We don’t always maximize utility. We bring emotion and bias, things that standard economic thinking would not predict.
Need an example? Here’s one in Kahneman’s book, Thinking Fast, Thinking Slow, via this helpful summary from ShortForm:
Students are split into two groups. One group is asked if Gandhi died before or after age 144. The other group is asked if Gandhi died before or after age 32. Both groups are then asked to estimate what age Gandhi actually died at. The first group, who were asked about age 144, estimated a higher age of death than students who were asked about age 32, with a difference in average guesses of over 15 years.
Clearly, standard rational thinking breaks down here. Of course, people wouldn’t place value based on something so obviously simple. Except that they do.
What Is Behavioral Economics?
A nuanced understanding of human behavior allows behavioral economics to provide a better understanding of economic behavior. If properly considered, behavioral economics can help lead to more effective policy interventions and business strategies for the real world. It allows for (or at least doesn’t ignore) irrationality and imperfections in humans. It’s not a rebuttal of standard economics, but rather an expansion of it. Think of it more as a comprehensive and nuanced understanding of economic behavior, making it a smarter and more relevant approach to addressing economic challenges.
Behavioral economics is perhaps best described by some of its concepts. Here are a few of them (borrowing the list from that same University of Chicago link above):
Availability Heuristic – the idea that people often rely on easily recalled information, rather than actual data, when evaluating the likelihood of a particular outcome. For example, people may think shark or bear attacks are a common cause of death if they’ve read about one such attack, but the incidents are actually very rare.
Bounded Rationality – people have limited cognitive ability, information and time, and do not always make the “correct” choice from an economist’s point of view, even if information is available that would point them toward a particular course of action. One could easily point to employee benefits as a place where Bounded Rationality comes into play – they are complex and people have limited time. More on this later.
Bounded Self-Interest – the idea that people are often willing to choose a less-optimal outcome for themselves if it means they can support others. Giving to charity is an example of bounded self-interest, as is volunteering.
Bounded Willpower – the idea that even given an understanding of the optimal choice, people will often still preferentially choose whatever brings the most short-term benefit over incremental progress toward a long-term goal. Exercise and healthy eating are both good examples here.
Loss Aversion – the idea that people are more averse to losses than they are eager to make gains. For example, losing a $100 bill might be more painful than finding a $100 bill would be positive.
Sunk-Cost Fallacy – the idea that people will continue to invest in a losing project simply because they are already heavily invested, even if it means risking more losses. Examples are a bad financial investment or maybe a car that needs constant repairs.
Mental Accounting – the idea that people think about money differently depending on the circumstances. For example, if the price of gas goes down, they may begin to buy premium gas, leading them to ultimately spend the same amount, rather than taking advantage of the savings offered by the lower price.
With these concepts and examples within, you can start to see why traditional economic models might miss some things. I’m sure we can all identify behaviors of our own that are “irrational” according to economics.
What Can Group Insurance Learn and Apply from Behavioral Economics?
If you’ve read through this paper so far, you’ve probably already started thinking about places in our day-to-day work where we observe irrational behavior. Whether you work for an insurer, a benefits broker and employer or you just want access to the best benefits, we all have biases in our way. But are we doing enough to acknowledge them and importantly are we doing anything to act on them?
It’s very easy for us to shrug our shoulders over the fact that 65% of US workers do not have income protection via disability insurance. But has the benefits industry really made serious efforts – with full consideration of these behavioral economic principles – to do something about it?
Yes, there is some great marketing material highlighting the value of income protection. Organizations like the Council for Disability Income Awareness highlight that disabilities and illnesses happen more than you think.
Despite those efforts, we haven’t moved the needle on getting these critical safety nets to more people. Disability and illness are still two of the major causes of financial hardship. Like, losing your home kind of hardship. People are not protecting their income despite the coverage being affordable and the stakes being so huge.
People are behaving irrationally
The study of behavioral economics allows us to put a name to irrational behavior. It allows us to explain why standard economic thinking can break down. What it doesn’t do is provide answers on how to overcome those irrational decisions. However, you can’t even begin to solve a problem until you really understand it.
So with that spirit, let’s tackle those irrational decisions from consumers with our behavioral economics hats on. Can we use the concepts above to start thinking about solutions collectively as an industry?
How Behavioral Economics Impacts Buying Decisions of Disability Insurance/Income Protection
Hopefully by now, you appreciate that employee benefits are a critical set of protections for workers. Without products like Disability Insurance, individuals and families are at significant risk of financial hardship.
Go back and read the paragraph on Bounded Rationality. Despite ample information available to make informed decisions, many people don’t understand the product and don’t have the time to learn. What do we do about it?
We can’t give people more time. Even with the snazziest marketing materials around, without enough time to see those materials, the message won’t get through. Statistics of bankruptcies, of lost homes and more haven’t done it – and it’s just not resonating with enough people.
So let’s go back to our basic list of behavioral economic concepts and see if we can understand how some of them apply:
Availability Heuristic – the key here is that people don’t think disability will happen to them. The product, “Disability Insurance” does a pretty poor job of describing what the product does. There is a lot of material that explains what the insurance product is, but it’s not moving the needle. The product replaces income in the event that a worker is mentally or physically unable to work. People can visualize that. So why on earth is it still called Disability Insurance? Never mind the labels of STD and LTD which mean even less to consumers.
Bounded Rationality – we touched on this already. Despite the high stakes of benefit enrollment, people don’t spend the time on it. And if they do, they spend their time thinking about their healthcare coverage (which they should, but perhaps not at the expense of other important protections). People simply don’t have the time to make rational decisions and we need to accept that. When people see the term “Disability” they likely skip right by and focus on more “important” things.
Bounded Willpower – this idea could be at play, but probably less of a weight than some others. If people did fully understand the product, they still might say that sacrificing the $20 per paycheck is not worth it for something that is unlikely to happen. This is a great example of taking short-term gains in sacrifice of a (albeit possible) long-term gain.
Loss Aversion – this is an idea concept that can really help educate people. Recall that Loss Aversion says that losing something can be more powerful than gaining something. A powerful tool can be to map a person’s earnings potential over their lifetime, to illustrate what is at stake.
Mental Accounting – if people (either at the employer or employee level) were given the choice to protect or not protect their income, at a small percentage of their wages – they might be more interested in purchasing the coverage. But at enrollment time, they just spent thousands on healthcare insurance, elected withdrawals for their 401(k), bought dental coverage and maybe life insurance. Once they get to something called “LTD”, they’ve spent too much money already today. It probably won’t happen, but I’m definitely going to the doctor this year. It doesn’t matter that LTD is cheap, they are done spending.
What Can Be Done About It?
There are a lot of smart and creative people working to deliver meaningful benefits to workers. When given the airtime, there are stories to tell in a way that really strike chords with potential buyers. While those efforts have allowed Disability Income to stay relevant in a crowded benefits market, there is still not enough meaningful progress in bringing these benefits to more workers. We must think differently if we want things to change.
The benefits industry is competitive. While camaraderie among insurers, brokers and employers is positive, it is a dog-fight to win and retain business. So let’s think with a growth mindset, not a fixed mindset. Can everyone take collective action to amplify the story?
When I revisit the behavioral economic concepts above, I think we really need to reconsider how the product is branded and positioned. Here are some things I think we all should consider:
- Can the name of our product actually change? The name “Income Protection” has been brought up, and I think that does a much better job of describing the coverage. There are obstacles to doing this, namely in what classifies as insurance. But “Disability Insurance” is clearly not working.
- Is the coverage affordable and accessible to all workers?
- Gig workers are taking up a larger, and larger share of the workforce. Does the product work to meet their needs?
- Lower wage workers likely find the coverage too expensive. Insurers have attempted simpler coverages in the past, but with no real traction to speak of. But can more be done to invest in designing a cheaper product – either through definitions of what constitutes a claim, or through a benefit that only pairs with SSDI?
I’ve had many conversations with people across the benefits industry. I have yet to find someone who disagrees with these things conceptually. This would need to be an effort by the insurers and the benefits brokers. These ideas, particularly changing the product name, would have to be an industry effort. If it is done with purpose, with enthusiasm and all together, then I believe it will take hold.
Are these changes small? Will anything happen easily? Of course not – but it would be irrational to not consider them.
Matt Desfosses
Managing Director
GC Smith Group
matthew.desfosses@guycarp.com
About Guy Carpenter / Smith Group
Smith LTD Management Group, Inc. is a disability and reinsurance consultant and a subsidiary of Guy Carpenter & Company, LLC, which is a global leader in providing risk and reinsurance intermediary services. Guy Carpenter is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy and human capital.
Smith Group provides this white paper for general information only. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. Smith Group makes no representations or warranties, express or implied. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. Please consult your insurance/reinsurance advisors with respect to individual coverage issues.
Statements concerning tax, accounting, legal or regulatory matters should be understood to be general observations based solely on our experience as reinsurance brokers and risk consultants, and may not be relied upon as tax, accounting, legal or regulatory advice, which we are not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas.
Readers are cautioned not to place undue reliance on any historical, current or forward-looking statements. Smith Group undertakes no obligation to update or revise publicly any historical, current or forward-looking statements, whether as a result of new information, research, future events or otherwise.
This document or any portion of the information it contains may not be copied or reproduced in any form without the permission of Smith Group, except that clients of Smith Group need not obtain such permission when using this white paper for their internal purposes.
The trademarks and service marks contained herein are the property of their respective owners.
© 2023 Smith LTD Management Group, Inc.
The content herein is not intended to provide legal, accounting, or other professional advice, and no liability is or will be accepted or assumed in connection with its use.
Related posts
