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Financial Planning > Tax Planning > Tax Loss Harvesting

Selling LTCI smarter: Prospect theory

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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.

Pincus used a square, four-cell chart to “frame” thinking about LTCI risk.



High probability

Big chance to win a lot.

Big risk to lose a lot.


Small chance to win a lot.

Small risk to lose a lot.

Researchers tested four different explanations of LTCI concepts, with each concept explanation fitting in one of the four cells in the frame:

  1. High-risk, big insurance “gains”: A policy could pay $4,500 in benefits per month, and 71 percent of older Americans need LTC services.
  2. Low-risk, big gains: A policy could pay $4,500 per month, and 17 percent of Americans will stay in a nursing home for a long time.
  3. High-risk, exposure to big losses: LTC expenses represent the biggest single threat to retirement income security.
  4. Low-risk, exposure to small losses: Americans face some risk of experiencing a big retirement savings loss due to LTC costs.

Pincus says the study produced the following results:

  • The consumers responded best to a hypothetical LTCI product explanation that talked about the low-risk of exposure to relatively small losses. A product description that emphasized that an LTCI policyholder would have a high probability of actually getting a modest amount of benefits came in second.
  • Responses differed by age. Consumers ages 30 to 59 – the consumers who are in what insurers now think of as the prime LTCI buying age – preferred a product description that emphasized that a policyholder would have a high probability of getting a modest amount of benefits.
  • The typical LTCI industry message that consumers face a big chance to lose a lot is deeply flawed, because relatively few consumers seem to have much interest in that kind of message.
  • Replacing a rational LTCI explanation with a deeply emotional story about a family’s past use of long-term care got some study participants to respond better to an argument about the need for LTCI to protect against big, highly probable losses, by getting the participants to think in terms of a past event instead of probability.

Pincus emphasized the need for more research based on prospect theory framing ideas.

When researchers experimented with using emotional stories to shape participant attitudes, for example, the 40-something study participants responded to an emotional story much better than the 30-something participants did.

That could be because younger participants preferred a more analytical approach, but it could also be that the emotional story used had more appeal for the older participants than for the younger participants, Pincus said.

“How would they respond to emotional stories of accidents?” Pincus asked, suggesting that might be an area for future research.

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