Real live American human beings may have their own peculiar way of thinking about all kinds of risk, including long-term care (LTC) risk.
Daniel Kahneman and his partner, Amos Tversky, created a new category of behavioral economics – prospect theory – by studying an apparent gap between how a professor of statistics would make decisions about risk and what ordinary people actually do.
Jeremy Pincus, a principal at Forbes Consulting Group and a former John Hancock research director, talked about the implications prospect theory may have for the LTCI community earlier this week in Orlando, Fla., at the Intercompany Long Term Care Insurance Conference.
Pincus used prospect theory concepts to analyze an old LTCI community question: Why don’t more Americans who can easily afford to insure themselves against LTC risk do so?
Insurance company executives and brokers often explain weak LTCI demand by citing rational reasons, such as the high cost of the product, or emotional reasons, such as consumers’ reluctance to think about the possibility that they might someday need care, Pincus said, according to a written version of his presentation.
Pincus suggested another possibility, based on prospect theory: The statistically based approach to risk assessment that insurers typically use clashes with the approach ordinary people typically use inside their own heads.
When Kahneman and Tversky created prospect theory, in a book published in 1979, they suggested that ordinary people tend to:
- Care more about gains and losses than the final outcome of a transaction;
- Care more about the size of a gain or loss in percentage terms than the absolute numerical size of the change; and
- Get more pain from losses than they get joy from comparable gains.
Because of the way people weight gains and losses, seeing the value of a portfolio drop to $100, from $200, would hurt more than seeing the value drop to $900, from $1,000, even though the consumer loses $100 in both cases, Pincus said.
Similarly, “the loss of $200 has a much larger psychological impact than a $200 gain” Pincus said.