Tackling financial inertia: Could nudge theory be the solution to consumer apathy?

18 September 2009

The latest Chartered Insurance Institute (CII) Thinkpiece Risky Business: "Nudging" you to make the "right" choices, written in partnership with RSA Insurance Group and the thinktank Reform, explores politicians' current love affair with nudge theory and spells out how the public could benefit from its use by the financial services sector.

Recent events have shown that no matter what you tell them people still don't put enough money aside for a rainy day. One explanation for why people don't save enough is that they're unable to accurately assess their own risks – the risk of unemployment, an accident or ill health, for example – and thus conclude that it's okay to do nothing because there's no reason to act.

In such instances, poor information or human psychology can prevent the right decision from being taken. Behavioural research shows that people taking financial decisions are frequently inclined to reach incorrect conclusions because of limited or poor quality information. Many people might know (or suspect) they are not saving enough for their retirement, but few have a real grasp of how much they should be saving to avert poverty in their old age. And even those that do struggle with willpower – saving can always be done later; the temptation to spend is stronger in the here and now.

'Nudge theory' combats this apathy by advocating a default choice that helps individuals make a "better" decision about their risks

Andy Haste, Group CEO of RSA Insurance Group plc, who commissioned the Thinkpiece, said, "Nudge should be about making it easier for people to make a better choice. Insurers have been mitigating risks for centuries and are already using nudge to help shape behaviour. That said, there is a risk that this can go too far and erode the ability to exercise basic judgment. These potential pitfalls are tackled in detail in the latest CII Thinkpiece - one of a series of four papers we've commissioned on the subject of risk ahead of the party political conferences."

David Thomson, director of policy and public affairs at the CII, said, "Nudge theory offers an approach that helps people make positive choices. The financial sector has long relied on the principles of nudge theory to tackle inertia and is using them more and more. It is now common to find health insurance that offers a discount on gym membership or motor insurance that uses financial inducements to dissuade young drivers from taking their car out after dark. Using nudge theory in this way benefits both the insurer and the insured, who in these examples might expect to live longer or experience fewer accidents. The decision of the Government to invest money in a default equity child trust fund if parents do nothing is another example of a nudge towards 'better' decisions.

"We believe that the concept of nudging people into the doing the right thing rather than being compelled is an idea worth debating. The Government's recent financial services white paper shows how nudge theory can be applied to improve access to fair and simple financial products. Nudge as a public policy mechanism is controversial – it is not a replacement for the exercise of individual judgement – but behavioural economics like nudge do offer a way to tackle the impasse of issues like under-saving. It argues that "an ideal system would … allow freedom over product design, while at the same time guiding people who would be best served by basic, cheap and accessible products in that direction and ensuring that wherever people do choose other options, they know about the basic alternatives."

Risky Business: "Nudging" you to make the "right" choices was written by Elizabeth Truss, deputy director of Reform and Nick Bosanquet a consultant director of Reform and professor of health policy at Imperial College London.

Elizabeth Truss, said, "Whilst an element of government protection is necessary; we have to be wary of too much nudging leading to a 'Sat Nav society', where people lose their ability to assess risks and insure themselves."

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