Do you love to win or hate to lose? Pro athletes get asked that question fairly regularly. What really drives them? Is there a right answer? Well, the results are in and people hate losing. Well, they hate losing more than they like winning at least.
Prospect theory explains that there is asymmetry between gains and losses, and it really is very dramatic. Let’s look at an example of how this works with money.
- You have $1,000 and you must pick one of the following choices:
Choice A: You have a 50% chance of gaining $1,000, and a 50% chance of gaining $0.
Choice B: You have a 100% chance of gaining $500.
2. You have $2,000 and you must pick one of the following choices:
Choice A: You have a 50% chance of losing $1,000, and 50% of losing $0.
Choice B: You have a 100% chance of losing $500.
The results of this study showed that an overwhelming majority of people chose "B" for question 1 and "A" for question 2. The implication is that people are willing to settle for a sure thing (even if they have a reasonable chance of earning more), but are willing to engage in risk-seeking behaviors where they can limit their losses. In other words, losses are weighted more heavily than an equivalent amount of gains. We have a loss aversion and the ratio is about 2 or 3:1.
What if I told you that you were more likely to become disabled than to pass away prior to 65. At no age is the risk of death greater than being disabled. For life insurance, the major problem is getting individuals to assess how much coverage they need. For disability insurance, the major problem is getting individuals to assess any need at all.
4 to 1
3.5 to 1
2.7 to 1
2.1 to 1
1.8 to 1
1.5 to 1
A majority of American adults have no private, long-term disability insurance, to replace lost income. The evidence for the risk is clear. And going back to prospect theory, it would be natural to theorize that most people would want this risk addressed.
Let’s consider why more private/personal disability insurance isn’t bought. Since we know that people are loss averse, we also know that they are averse to paying premium. Even though there is a great risk of loss in becoming disabled and not being able to earn income, the loss of the premium dollar is a sure thing…..Throw this idea into the mix though… What if they never had the money to begin with? As in, if the premium is deducted from their paychecks. If the money never reaches their bank accounts, the premium for disability becomes very palatable.
People Love Getting Money Back, Even If It Was Always Theirs In The First Place.
Think about tax refunds. Tax refunds are returns of overpaid taxes at 0% interest. This seems like a pretty sour deal, especially considering how much we complain about Money Market and CD Rates. So why are people so much more happy to collect 0% interest on their money than to take what they would have overpaid in taxes and save it over the same period of time for a positive rate of return? Maybe it’s because underpaid taxes carry a 3% interest rate, but I don’t think so.
People Like Return Of Premium.
They like to see cash value in their Whole/Universal life policies, even if the insurance is only for death benefit. They want to get something for their unused premiums, even if it’s only their own money back at 0% rate of return.
Let’s say you recently started a new job and were offered 2 disability options. Both pay ⅔ of your salary if you are unable to work for more than 30 days, and for so long as you are disabled, up to age 65.
Policy A: Will reimburse you $1200 if you do not file a claim within 5 years. It costs $90/mo.
Policy B: Has no refund. It costs $70/mo.
The rebate policy was preferred by 57% of respondents. The average odds of collecting disability payments and not receiving some or all the refund was 3.6%.
So what this means is that out of 1000 people, 570 would choose to basically take out a 5 year annuity with a 100% penalty (if they change jobs or become disabled) for a 0% rate of return, instead of doing something else with the $20 per month. WOW!
The availability heuristic comes into play as well. The Availability Heuristic and The Proclaimers If a recent outcome was negative without regard to the odds a person will put more weight on that situation.
If someone has had a family member or friend pass away or become disabled, they are more apt to see value in covering that risk even if their age, health, or financial situation is completely different. I just had a client call to buy life insurance because a friend of his died piloting a small plane that crashed. My new client is not a pilot himself. He also happens to be someone I had approached 6 months earlier about adding more life insurance and he put it off.
Tennis great Jimmy Connors knew his own emotions and stated that “I hate to lose more than I love to win.” As a consumer, this is built into our psyche. Many financial decisions are ultimately based on emotion. Taking a step back to fully assess the relevant details is key. This is especially true on a risk management choice. Force your emotional mind take a back seat to your practical mind long enough to make a smart decision.