Are you making good financial choices?

In 2015, US insurer Prudential ran a series of ad campaigns highlighting the biases that lead people to make poor financial decisions. These biases, known as heuristics, are mental shortcuts that enable us to make quick decisions that are practical but not necessarily optimal.

I was recently reflecting on decision making in the context of insurance. Consider these facts: about 90% of Kiwi motorists have car insurance, whilst just 25% of income earners hold income protection cover. Why the gap? The Financial Services Council offers some possible explanations:

  • Kiwis are more familiar with car insurance than income protection insurance;

  • Reliance on ACC for income support; and

  • Perception that income protection cover is too expensive.

Another possible explanation is the concept of loss aversion. Studies have shown that the pain of a loss is twice as great as the pleasure of a gain. In other words, people are more worried about paying the cost of repair after a car accident than the risk of losing income if they are unable to work due to injury or illness.

Don’t believe me? Take a moment to consider how much more likely you would be to purchase income protection cover if you received your annual salary at the start of each year and you were required to pay it back if you were unable to work.

Another heuristic that leads us to make poor insurance choices is availability bias. We tend to worry about things right in front of us. A famous study by the founders of Behavioural Economics, Daniel Kahneman and Amos Tversky, showed that people assessed the risk of an earthquake in California to be greater than the risk of an earthquake in the United States (obviously, California is a state of the USA). The study exploited the fact that earthquakes commonly occur in California, are often reported on by the media, and therefore, more easily available to recall. Consequently, it’s not surprising that we tend to be more concerned about car accidents, which most of us are regularly exposed to.

You can find out more about the insights offered by Behavioural Economics here. And to avoid potentially costly financial mistakes, it pays to get some good advice.

Brought to you by Future Insurance Services, experts in Financial Advice.

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