Friday, 14 March 2014

Add-on insurance and default options

One of the most basic and intuitive ideas that has come out of the behavioural change literature is the opt-in versus opt-out distinction. Essentially, because of psychological bias, people are likely to end up 'choosing' the default option. So if, for example, the default option is to not be opted into a pension savings plan a person is likely to end up not saving enough for retirement. This simple observation partly motivated the save more tomorrow plan that stands to revolutionise retirement saving.
        A context where default options are often used strategically is check boxes on online (or hard copy) forms. Suppose, for example, you want to travel from London to Birmingham and go to book your ticket online. If you are going by train then once you've sorted out the times of the trains etc. you will be offered the chance to buy basic travel insurance. In this case the box is not ticked and so the default option is no travel insurance - you have to click a mouse button to get insurance. If you are going by coach, by contrast, the box is ticked and so the default option is travel insurance - you have to click a mouse button to remove the insurance. The Financial Conduct Authority is concerned that such default opt-in options are essentially a form of miss-selling and so should be banned.
         To the standard economic model this all seems a little crazy. There is seemingly no-cost at all in clicking a mouse button to switch from opt-in to opt-out. And travel insurance is a product that some people might want to buy. So, why should we be banning default opt-in options? Should we not put the onus on consumers to make sensible decisions?
         To get some insight on these questions I think we need to take a step back and ask why default options matter. The standard reason given for why defaults matter is procrastination. A person, for instance, puts off changing their pension plans, until tomorrow, and then the day after, and then the day after that. Before long they have retired without the savings they hoped they would have. But, while this can explain the success of the save more tomorrow plan it says nothing about online check boxes. In the latter case the form is being filled here and now and so the decision simply cannot be left until tomorrow.
          We need, therefore, to question why defaults can matter beyond procrastination. I'll point to two reasons. First, we have a psychology bias to 'trust the seller knows what we want'. We naively think that the default option must be the right option - why else would it be the default. A little thought shows that this logic is really na├»ve - the seller wants to make as much profit as possible. But, we still fall for the trap. And things get worse when we take into account a second factor, namely that of anticipated regret. By unchecking the box to buy default travel insurance you set yourself up to feel regret if the insurance would subsequently have been useful. The fear of that regret may bias you towards sticking with the insurance. This is a variant of the endowment effect - you value something more when you feel you already own it. Observe how ridiculous this can end up being: When you sat down to buy the tickets you had no thoughts about travel insurance. But once the 'seed is in your head' and you have to 'consciously do something' to opt-out, travel insurance suddenly seems an essential!
          Seen in this light, I think the Authority is right to get involved and ban default opt-ins. They are essentially a way of 'fooling' the customer into feeling they need something they do not. To say that consumers have the choice to opt-out is not really the point. Consumers are forced to consciously opt-out of something and pay the psychological cost for doing that. Indeed, notice that everyone suffers - some buy something they do not need, while others pay (a small) psychological cost of 'giving something up'. If travel insurance is worth buying the onus should be on the company to prove its worth buying. 

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