Financial institutions more and more offer their products and services in an online environment. The choices consumers make are influenced by how choices are presented. In an online experiment, the AFM researched the effects of offering more choices on (hypothetical) insurance coverage decisions.
The way firms present and offer their products can lead to better outcomes for financial consumers. However, unwanted and/or unintended steering towards certain products is also possible through the choice architecture. Steering towards products that maybe less suitable.
Choice architecture guides
In the report Consumer Behaviour: understanding, guiding and measuring, the AFM writes: “Behavioural insights teach us that preferences are shaped by our environment: the judgements and decisions we make are influenced by those around us, depend on the moment and our state of mind, and are guided by the way a choice is presented.”
As a conduct supervisor, we want to ensure that people are able to make sensible financial decisions and the choice architecture and how choices are presented, is an integral part to that. Guiding or steering consumers towards certain products should take into account what is in the best interest of the customer.
Many people often perceive financial products to be complex. They often choose a middle option, not too expensive and not too cheap, a phenomenon dubbed ‘compromise effect’ in academic literature. Marketers could use such psychological insights to steer customers towards certain products, which might be preferred by the sellers because of their higher margins and not because they are best suited for the customer.
Experiment with non-life insurance
In an online hypothetical experiment, 800 respondents from the AFM Consumer Panel were randomly assigned to one of three groups, and asked which home insurance and which liability insurance they preferred. The control group had two choices, a standard policy (policy A) or a more expensive policy with more coverage (policy A+). The two other experimental groups were offered an additional option: one group also got to see an insurance policy with a lower price and less coverage (policy A–, in addition to policies A and A+), and the other experimental group was presented with an even more expensive policy with even more coverage (policy A++, in addition to policies A and A+).
Adding the cheaper policy for the home insurance led to an increase in people choosing the standard policy A, and a decrease for policy A+. Without the cheaper alternative 57% chose the more expensive policy A+, but when the cheaper alternative was included, only 40% chose policy A+.
For the liability insurance, adding the more expensive policy A++ led to differences in choices for the standard policy A that cannot be explained rationally. If you prefer the cheaper option, adding an even more expensive option should not change that preference. However, with only the A+ policy, 71% choose the standard policy, but when compared with two more expensive other policies (A+ and A++), only 49% chose this insurance policy.
Adding an extra option influences insurance decisions (AFM Consumer panel experiment, May 2019)
Apply Behavioural insights
Consumers are steered and guided by the choice architecture and the number of options on offer. What guidance works where, depends on the context. As formulated in the Principles for the use of consumer behavioural insights, the AFM expects firms to keep up to date on behavioural insights, use these insights to promote sensible decisions among consumers, and measure the effects. The AFM summarized the behavioural insights that are most relevant to financial firms in the report Consumer Behaviour: understanding, guiding and measuring. Firms’ choice architectures should contribute to fair and transparent financial markets and prosperity.
The AFM is committed to promoting fair and transparent financial markets.
As an independent market conduct authority, we contribute to a sustainable financial system and prosperity in the Netherlands.