BEHAVIORALFINANCIAL PRODUCT DEVELOPMENT:

Primer, Progress, FrontiersJonathan Zinman

Dartmouth College andIPA’s U.S. Household Finance Initiative

(also J-PAL, NBER, etc.)

A. Primer

Symptoms and Causes: Behavioral (Household Finance) Economics 101

Applications: Markets Your employees

Scope today More about product development Much less about marketing, persuasion

Tmrw at Behavioral Finance Forum

Financial I l lness: Symptoms

Widespread low financial resiliency

Little savings for many households High debt reliance: expensive High “money on the table”

Poor shopping, mediocre

management

Low financial sophistication

Problems => Opportunities

A. Primer

Financial I l lness: Causes(Behavioral Economics 101a)

Cognitive biases that stack deck toward spending/borrowing, away from saving/accumulating

In preferences: costly self-control, loss-aversion In expectations: “things will get better” (or at

least not worse) In price perceptions

Underestimation of compound interest Underestimation of borrowing costs

Limited attention

# 1

A. Primer

Financial I l lness: Causes(Behavioral Economics 101b)

Mistakes borne of misguided heuristics, other cognitive limitations

Information/choice overload Anchoring Low (financial) literacy, numeracy

# 2

A. Primer

Financial I l lness: Causes(Behavioral Economics 101c)

Limited opportunities for learning

… on high-stakes decisions Mortgage/house Job Marriage Car (and financing it)

Even high-frequency decisions can have uncertain long-run implications

Credit card use (what’s right debt load for me/my family)?

Changing life circumstances creates moving targets

# 3

A. Primer

Financial I l lness: Causes(Behavioral Economics 101d)

Markets sometimes exacerbate consumers’ cognitive “bugs”

Advice markets are a mess and limited in scope

Who covers the household balance sheet?

For the mass market? Price competition in product markets helps,

but only partly

# 4

A. Primer

DECISION

Biases in preferences• Time-inconsistency• Loss aversion

Biases in expectations• Overconfidence• Over-optimism

Biases in price perceptions/valuation• Exponential growth bias• Anchoring

“Cross-cutting” biases/heuristics/ limitations• Anchoring• Limited attention• Innumeracy

A. Primer

Taxonomy of Behavioral Factors (see DellaVigna JEL)

DECISION

Preferences

Biases/limitations in cognition that affect perceptions about how to maximize utility

subject to constraints(And hence affect other key parameters we

might model: expectations, prices, transaction costs…)

A. Primer

Alternate Taxonomy

B. Progress

By way of examples: 10 pilots (alpha-/beta-tests) All with “retail” financial service firms (D2C) “Wholesale”– particularly through

employers– is another promising channel (E2C). A la HelloWallet

B. Progress

Completed Pilot 1: Performance Bond for Smoking Cessation

“Put Your Money Where Your Butt Is!” Bank offered in Philippines Bank account offered to smokers “Deposit money you were spending

on cigarettes” Agree to a urine test in 6 months

If nicotine free: get your money back (no interest) If not nicotine free: your money goes off to charity

Result: 11% opened an account 30 percentage point increase in smoking cessation

Example of a “commitment contract”

Commitment Options

B. Progress

Commitment contract = voluntary restriction, or self-provided added incentive, in service of goal attainment Performance bonds Liquidity restrictions (e.g., spending limits) “Cut me offs” Peer support/social reputation (stickk.com, other

models) (Also automation; e.g., auto-deductions)

Completed Pilot 2:Messaging as a Product Feature

Pilot With savings account

holders at 3 different banks in 3 different countries

Reminders raised balances by 6%

Now extending todebt reduction, budgeting,and planning goals

SMS Reminders for Goal Attainment

B. Progress

Completed Pilot 3:Borrow Less Tomorrow (BoLT)

B. Progress

Behavioral Kitchen Sink for Debt Reduction Decision Aid Escalating Repayments Peer Support Reminders/Feedback (Monitor progress using credit reports)

Save More Tomorrow™ as a guide High-touch pilot test at free tax prep site in Tulsa

41% take-up rate 37% plan escalating repayments; 26% enlist peer supporters 51% on-schedule after 12 months (is this high or low??)

Pilots 4-10: Financial Products Innovation Fund

“The Financial Products Innovation Fund was created as a joint effort between IPA’s US Household Finance Initiative and the Ford Foundation to support the development of scalable, market-tested products that help households make better financial decisions, escape cycles of debt, build assets and achieve financial resiliency.”

• Emphasis on product development informed by behavioral research• Theory, evidence, principles

• Competitive call for proposals launched in August 2011

• Seven projects awarded funding in January 2012

• Product development and “alpha-testing” for feasibility and level of demand• Will also be doing some analysis of demand determinants

• Pilot tests currently underway (Apr – Dec 2012); results by May 2013B. Progress

“Pay Yourself Back” – Two Pilots

• Problem: Hard to get started saving

• Solution: Seamless conversion of loan/DMP payments to savings once loan/DMP is paid off

• Behavioral approaches: Harness habit formation, redirect mental accounting, easy on-ramp (use existing accounts)

• Key Features: Upfront commitment, back-end automation

• Take-up rate of about 10%

B. Progress

Pay Back Yourself– “Get Saving!”

B. Progress

“Frictionless Savings” – Two Pilots

• Problem: Easy to spend on impulse, but not to save (on impulse)

• Solution: Clear path to saving at times when you are most liquid• For example: at the check cashing window

• Approaches: Redirect impulsivity, meet people where they prefer to conduct business, streamline bank account sign-up

• Key Features: MicroBranch: Upfront commitment, back-end automation; RiteCheck: “impulse saving”

• Target Market: Low-income check cashing customers in San Jose & New York City

• Take-up rate: about 25%.B. Progress

“Frictionless Savings” – Two Pilots

B. Progress

“TGIF: The Goal is Freedom” Loan

• Problem: Small dollar loans are expensive, and have high default rates

• Solution: Borrowing accepting 5-day delay in disbursement gets 28% - 69% discount

• (Sister product: emergency line of credit with “frictionful” drawdowns)

• Approaches: Incentivize planning, risk screening-by-sorting

• Key Features: Delayed disbursement, frame interest as savings to incent improved financial planning; (voluntary liquidity restriction)

• Target Market: Roanoke credit union members, 61% designated low-income

• Take-up rate: about 40%B. Progress

“The Trust Card” Credit Card

• Problem: Yield-maximizing strategy for many households is to pay down high- interest debt, but many only make minimum payments each month

• Solution: Behavioral Credit Card for debt consolidation

• Approaches: Decision aid; default option; commitment options

• Key Features: default to accelerated payment plan; built-in planning tool; restricted access to liquidity going forward; option of further voluntary restriction

• Target Market: Low-income credit union members in Washington Heights, NYC

• Takeup rate: About 17%B. Progress

“The Trust Card” Credit Card

B. Progress

“Now and Later Account” Restricted Withdrawal Account

• Problem: The temptation of lump sums (some jobs, many tax refunds)

• Solution: Voluntarily restrict own access to lump sums

• Approach: Decision aid, commitment, and automation bundled with savings account

• Features: Budget commitment to withdrawal schedule

• Target Market: Students via Single Stop USA’s Community College Initiative (smooth disbursement of student loan payments)

• Expected Launch: August 2013

B. Progress

“The Now & Later Account”(See also “Aid Like a Paycheck”)

The Now&Later Account

B. Progress

Next Steps

• Pilot products: Scale, Refine, Evaluate• With randomized-control testing

• New ideas: Develop and launch several new alpha-tests

B. Progress

Progress: How We Make it

A Virtuous Cycle:R

DTest

B. Progress

C. Some Frontiers

Innovations in small-dollar space Documentation Peer referrals Commitment options

Loan shopping Cracking willingess-to-pay key Transparent pricing <-> Scalability

Personal financial management Content, take-up, engagement

Summing Up

Behavioral insights can help guide how you help people (customers, employees) deal with money Product DesignMarketingPricingProcess (e.g., “on-ramps”)Communication/Engagement Etc.