Contingencies Online - July/August 2009

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Just as a more realistic understanding of human nature has enriched economic theory, so is it likely to benefit applied fields like actuarial science. At the most general level, discoveries on heuristics and biases by the Kahneman and Tversky school provide a useful alternate perspective to the classical doctrines of Homo economicus, rational expectations, and efficient markets. These latter doctrines are certainly useful frameworks for specific types of economic theorizing, but the discoveries of behavioral economics—to say nothing of recent economic events—suggest that they are not the last word on which to base practical business, regulatory, and strategic decisions.

Second, being mindful of the fact that insurance agents, managers, underwriters, and policyholders are Homo sapiens rather than Homo economicus lends a useful perspective on actuarial predictive models as corrective tools (eyeglasses for myopic and boundedly rational minds) that can help rationalize inefficient markets.

Finally, Thaler and Sunstein’s concept of libertarian paternalistic nudges suggests a new role for actuaries and other financial professionals as data-driven choice architects. Current events suggest that this could be a socially beneficial development. Selecting a mortgage, for instance, is an example of a fraught choice where people can be led astray through both simple confusion and cognitive effects like availability cascades. The ongoing mortgage crisis suggests that it is in everyone’s interest for financial services companies to do more than simply offer a plethora of optimally priced products from which a consumer can choose. When designing new products and benefit plans, participating in marketing and customer-relationship initiatives, and helping design distribution strategies, actuaries can make choice architecture part of their job.

JAMES GUSZCZA, a fellow of the Casualty Actuarial Society and member of the American Academy of Actuaries, is a senior manager at Deloitte Consulting.

References

Ariely, Dan, Predictably Irrational: The Hidden Forces That Shape Our Decisions, HarperCollins, 2008.

Becker, Gary S., The Economic Approach to Human Behavior , University of Chicago Press, 1976.

Guszcza, James, “Analyzing Analytics,” Contingencies, July/August 2008 http://www.contingencies.org/julaug08/analytics.pdf. Johnson, Eric J., Hershey, John, Meszaros, Jacqueline, and Kunreuther, Howard, “Framing, Probability Distortions, and Insurance Decisions,” Journal of Risk and Uncertainty, Vol. 7, No. 1, August 1993 http://www. springerlink.com/content/x535827t2m525776/fulltext.pdf. Lewis, Michael, Moneyball: The Art of Winning an Unfair Game, W. W. Norton & Co., Inc., 2003. Samuelson, William, and Zeckhauser, Richard, “Status Quo Bias in Decision Making,” Journal of Risk and Uncertainty, Vol. 1, No. 1, March 1988 http://www.springerlink.com/content/h1548722q126n043/fulltext.pdf.

Skurnick, David, “The Underwriting Cycle,” CAS Underwriting Cycle Seminar, 1993 http://www.casact.org/pubs/forum/93sforum/93sf377.pdf. Sunstein, Cass R., and Thaler, Richard H., “Libertarian Paternalism

Is Not an Oxymoron,” University of Chicago Law Review 70, 2003 http:// faculty.chicagobooth.edu/richard.thaler/research/LIbpatLaw.pdf.

James Surowiecki, James, The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations, Little, Brown, 2004.

Thaler, Richard H., and Sunstein, Cass R., Nudge: Improving Decisions About Health, Wealth, and Happiness, Yale University Press, 2008.

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