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© Diamond Management & Technology Consultants, Inc. Behavioral Economics: Implications for an Aging Population's Wealth & Health Decisions Anand S. Rao September 23 rd, 2008 For more information contact: Anand S. Rao Partner Anand.Rao@diamondconsultants.com Mobile: 617.633.8354
© Diamond Management & Technology Consultants, Inc. | 2 Agenda What is Behavioral Economics (BE)? What is the relevance of BE in Health/Wealth Decisions? How can we model, simulate, and implement behavioral change? Agenda
© Diamond Management & Technology Consultants, Inc. | 3 Reflexive & Reflective Systems of the Brain What is Behavioral Economics? REFLEXIVE SYSTEM (Automatic) People are Emotional Driven by social influence Averse to losses Have bounded resources REFLECTIVE SYSTEM (Thinking) People are Rational Driven by self-interest Maximize utility Have unbounded resources Source: Diamond Analysis; Your Money and Your Brain by Jason Zweig
© Diamond Management & Technology Consultants, Inc. | 4 Rules of Thumb of our Reflexive System What is Behavioral Economics? ANCHORING ENDOWMENT EFFECT STATUS QUO BIAS MENTAL ACCOUNTING RELATIVITY & CHOICE LOSS AVERSION HOT vs COLD STATES HYPERBOLIC DISCOUNTING BANDWAGON EFFECT Source: Diamond Analysis; Nudge by Richard Thaler and Cass Sunstein; Predictably Irrational by Dan Ariely NOT EXHAUSTIVE
© Diamond Management & Technology Consultants, Inc. | 5 Behavioral Economic Principles: Anchoring What is Behavioral Economics? ANCHORING People start with a reference point and make (inappropriate) adjustments while answering questions and making choices ANCHORING People start with a reference point and make (inappropriate) adjustments while answering questions and making choices 1.How Happy are you? 2.How often are you dating? CORRELATION: 0.11 1.How often are you dating? 2.How Happy are you? CORRELATION: 0.62 Source: Nudge by Richard Thaler and Cass Sunstein
© Diamond Management & Technology Consultants, Inc. | 6 Behavioral Economic Principles: Status Quo Bias What is Behavioral Economics? ‘STATUS QUO’ BIAS & POWER OF DEFAULTS People have a strong ‘status quo’ bias and often fail to take pro-active action to change the default ‘STATUS QUO’ BIAS & POWER OF DEFAULTS People have a strong ‘status quo’ bias and often fail to take pro-active action to change the default Why is organ donation in Denmark below 5%, while in neighboring Belgium is close to 100%? Source: Nudge by Richard Thaler and Cass Sunstein
© Diamond Management & Technology Consultants, Inc. | 7 Behavioral Economic Principles: Mental Accounting What is Behavioral Economics? MENTAL ACCOUNTING Mental accounting is an internal control mechanism of the ‘reflexive’ part of the brain to compartmentalize complex decision-making MENTAL ACCOUNTING Mental accounting is an internal control mechanism of the ‘reflexive’ part of the brain to compartmentalize complex decision-making Source: Mental Accounting Matters by Richard Thaler in Journal of Behavioral Decision Making, 1999 You have just won $30. Now choose between 1.A 50% chance to gain $9 and 50% chance to lose $9 2.No further gain or loss Choice 1: 70% Choice 2: 30% Scenario A You have just lost $30. Now choose between 1.A 50% chance to gain $9 and 50% chance to lose $9 2.No further gain or loss Choice 1: 40% Choice 2: 60% Scenario B You have just lost $30. Now choose between 1.A 33% chance to gain $30 and 67% chance to gain nothing 2.A sure $10 Choice 1: 60% Choice 2: 40% Scenario C
© Diamond Management & Technology Consultants, Inc. | 8 Additional Behavioral Economic Principles What is Behavioral Economics? Source: Diamond Analysis; Nudge by Richard Thaler and Cass Sunstein; Predictably Irrational by Dan Ariely Rule of ThumbDescription Endowment Effect People place a higher value on objects they own relative to objects they do not Relativity & Choice Offering customers excessive options to choose from can result in purchase paralysis; People rarely choose something in absolute terms; they focus on the relative value amongst options Hot vs Cold States People’s decisions under aroused or ‘hot’ states tend to be significantly different from ‘cold’ calculated decisions Bandwagon Effect People have a strong tendency to conform to the social norms and often do things because others do Loss Aversion People prefer avoiding losses rather than acquiring gains. Studies suggest that losses are as much as twice as psychologically powerful as gains Hyperbolic Discounting Consumption now and in the near future is preferred to consumption into the farther future; The greater the uncertainty about this future the less the preference
© Diamond Management & Technology Consultants, Inc. | 9 Behavioral policy interventions with respect to retirement savings is showing early signs of 'nudging' consumers towards higher savings rate Relevance of BE in Health/Wealth Decisions BE InterventionsEmployee-Weighted Participation Rate (Post-PPA) Source: Diamond Analysis, Measuring the Effectiveness of Automatic Enrollment, Vanguard Center for Retirement Research 1.Pension Protection Act (PPA) 2006 Automatic enrolment of employees in 401(K) with explicit opt-out instead of voluntary opt-in (Default) Automatic increase of the percentage of salary directed to the plan (Pre- commitment) Default investment into three broadly diversified investments – balanced funds, lifestyle funds, and managed accounts (Choice) 2.Save More Tomorrow (SMaRT) Employees pre-commit to increase in contributions well before their scheduled pay increases or bonus payment (Pre-commitment, Loss Aversion) Employees can opt-out at any time (Default) % of Employees Median Contribution Rate (Post-PPA) % of Salary Contributed
© Diamond Management & Technology Consultants, Inc. | 10 In the absence of policy intervention Federal spending on healthcare will rise from 16% of GDP in 2007 to 25% of GDP in 2025 Relevance of BE in Health/Wealth Decisions
© Diamond Management & Technology Consultants, Inc. | 11 Slightly over 4% of the Medicaid enrollees account for close to 50% of the Medicaid expenditure Relevance of BE in Health/Wealth Decisions
© Diamond Management & Technology Consultants, Inc. | 12 Simple behavioral interventions can influence what people eat and how much they eat Relevance of BE in Health/Wealth Decisions OBESITY 1.Obesity causes at least 300,000 excess deaths 2.Obesity in adults resulted in health care costs of $93 billion in 2002 3.Lifetime costs related to diabetes, heart disease, high cholesterol, hypertension and stroke among obese are $10,000 more than the non-obese 1.Placing candies three feet away from one’s desk reduced volume of chocolate consumption by 5 to 6 chocolates a day (Self-control) 2.Subjects provided with a bowl of M&Ms in 10 colors ate 77% more than people given a bowl with only 7 colors (Visceral effects) 3.Food stamp benefits raise food expenditure more than an equal amount in cash (Mental Accounting) 4.Pre-ordered healthy-pack options encouraged healthy eating by Food Stamp Beneficiaries in Connecticut and North Carolina (Defaults) 5.Having more unhealthy choices reduces the chances of health options being selected – Salad, Hamburger, Cake vs Salad and Hamburger (Choice Relativity) BE Interventions Source: Could Behavioral Economics help improve Diet Quality for Nutrition Assistance Program participants, USDA, Economic Research Service, Diamond Analysis
© Diamond Management & Technology Consultants, Inc. | 13 Addressing more fundamental issues, such as medical malpractice tort costs may require policy interventions by Government Relevance of BE in Health/Wealth Decisions BE Interventions 1.Unbundle healthcare premiums to include cost of medical malpractise litigations (Accessibility and Salience) 2.Health insurance companies must be permitted to offer plans with and without the right to sue for negligence (Choice) 3.Make ‘waiving’ the right to sue as the default and retaining the right would cost more (Defaults) 4. Change the ‘right to sue’ only for intentional or reckless wrongdoing and not for negligence to reduce malpractise premiums MEDICAL MALPRACTISE COSTS (in $Bn) 1.Medical malpractice tort costs have increased 229% between 1990 and 2006 2.Annual rate of increase is 11.1% since 1960 compared to 8.2% for all other tort causes 3.Exposure to medical malpractice liability is around 5-9% of hospital expenditures Source: Diamond Analysis; Insurance Information Institute; Nudge by Richard Thaler and Cass Sunstein
© Diamond Management & Technology Consultants, Inc. | 14 Agent-oriented behavioral modeling and simulation offers a systematic way of designing and implementing behavioral interventions Agent-Oriented Behavioral Modeling Market Research Understand consumer beliefs, aspirations, attitudes, behaviors, and demographics Behavioral Economics Understand ‘reflexive’ BE principles that determine health and wealth decisions Predictive Analytics Use multiple data sources (diagnostics, prescription, demographics) to predict risk groups and costs Agent-Oriented Behavioral Modeling & Simulation Modeling consumer beliefs, desires, and behaviors to simulate different scenarios and evaluate impact of consumer health/wealth decisions on physical and financial well-being Behavioral Intervention - 1 Behavioral Intervention - 2 Behavioral Intervention - n Agent-Oriented Behavioral Modeling & Simulation Feedback Loop Source: Diamond Analysis
© Diamond Management & Technology Consultants, Inc. | 15 Diamond's market research on baby boomer health and wealth attitudes and behaviors identified five significant clusters of consumers Source: Diamond Retirement Study, 2008 Aspirants 31% (56yrs/ $50K) Affluent Sophisticates 24% (62yrs/ $98K) Retired Settlers 15% (66yrs/ $50K) Survivors 10% (57yrs/ $24K) Moderates 20% (57yrs/ $31K) Percent of population Avg. Age/ Avg. Income High Financial Confidence Low Health Consciousness Low Financial Confidence Low Health Consciousness Low Financial Confidence High Health Consciousness High Financial Confidence High Health Consciousness Agent-Oriented Behavioral Modeling
© Diamond Management & Technology Consultants, Inc. | 16 The five segments are clearly differentiated in terms of their health consciousness (e.g., regular exercise, health insurance cover, health risk during retirement) Affluent Sophisticates Aspirants Retired Settlers ModeratesSurvivors Increasing Health Consciousness % who exercise at least 3 hours a week % who strongly agree that they have adequate health insurance % who ranked physical health as most at risk during retirement Agent-Oriented Behavioral Modeling Source: Diamond Retirement Study, 2008
© Diamond Management & Technology Consultants, Inc. | 17 The five segments are also differentiated in terms of their financial confidence (e.g., financial preparedness for retirement and healthcare issues, longevity risk) Affluent Sophisticates AspirantsRetired Settlers Moderates Survivors Increasing Financial Confidence % confident of being financially prepared for retirement % confident of being financially prepared for healthcare issues that arise later in life % who ranked finances as most at risk during retirement Agent-Oriented Behavioral Modeling Source: Diamond Retirement Study, 2008
© Diamond Management & Technology Consultants, Inc. | 18 Findings from Behavioral Economics, Market Research, and Predictive Analytics can be combined to model individuals as software agents Agent-Oriented Behavioral Modeling Beliefs Desire/ Goals Intentions Informational state Facts about the world Beliefs about other agents Demographic data Beliefs about diet & exercise Impact of diet & exercise on cholesterol, stroke, etc. Current diet and exercise behaviors Social influence on beliefs Agent-Oriented ModelingExample: Cardiovascular Disease Motivational state Committed desires are goals Social influence on individual goals Deliberative state Commitment to abstract sequence of goals or specific actions Diet and exercise goals Level of commitment or self-control to goals Impact of social influence on goals Patterns of different diet and exercise patterns (e.g., regular vs sporadic) Varying impact of diet and exercise on cardiovascular events – stroke, Myocardial infraction (MI), etc. Behaviors of thousands of consumers can be modeled and simulated to evaluate impact of behavioral interventions on individual well being as well as healthcare costs Source: Diamond Analysis
© Diamond Management & Technology Consultants, Inc. | 19 Simulating over 1,000 individuals as software agents helps determine the impact of behavioral interventions on total cost and well being Relevance of BE in Health/Wealth Decisions Source: Diamond Analysis; AnyLogic Simulation
© Diamond Management & Technology Consultants, Inc. | 20 Conclusions Behavioral Economics embodies principles that explain the workings of the 'reflexive' brain and help in developing interventions to change our behaviors Behavioral Economics principles are being successfully used to change how people make decisions with respect to their health and wealth Combining predictive modeling and behavioral intervention already practised within the healthcare sector, with agent-based behavioral modeling offers a unique way to model, simulate, and implement behavior changes Agenda
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