1 / 28

Sandie McHugh and Rob Ranyard Bolton, UK IAREP-SABE Joint Meeting Rome September 3-6 2008

Credit Consumers’ Payment Protection Insurance Decisions: The Effect of Relative Cost and Level of Cover. Sandie McHugh and Rob Ranyard Bolton, UK IAREP-SABE Joint Meeting Rome September 3-6 2008. CREDIT AND RISK. Consumer Credit – loans increased 3 X in 10 years.

cairo-odom
Download Presentation

Sandie McHugh and Rob Ranyard Bolton, UK IAREP-SABE Joint Meeting Rome September 3-6 2008

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Credit Consumers’ Payment Protection Insurance Decisions: The Effect of Relative Cost and Level of Cover Sandie McHugh and Rob Ranyard Bolton, UK IAREP-SABE Joint Meeting Rome September 3-6 2008

  2. CREDIT AND RISK • Consumer Credit – loans increased 3 X in 10 years. • - Britons owe more than Gross Domestic Product • - Increase indebts – estimated 22% people having difficulties. • Loans - risk that future repayments cannot be met. • - changes in circumstances, such as being unable to work. • Consequences of repayment difficulties • Increasing debt – loans taken out to repay other loans - consolidation loans • Spiralling debt = difficulties with other household bills • - Insolvent - loss of assets - goods (bailiffs) property (repossession). • - Poor credit rating = future loan access • Future expenditure and goals adversely affected • - holidays – consumer goods - lifestyle changes. IAREP/SABE ROME 2008

  3. DIFFUSING RISK OF DEFAULT OF REPAYMENTS Decision Maker may:- • Not recognise risk exists - ignore it • Recognise risk but decide no action necessary • Recognise risk and diffuse it - Use insurance to provide cover - Payment Protection Insurance for loans and credit cards - Use other strategies IAREP/SABE ROME 2008

  4. Payment Protection Insurance Benefits Life cover if you are over 18 years and below 70 – the balance of your loan in the event of death would be paid in full Accident and sickness cover if off work If you are working, and over 18 and under 65, cover for accident and sickness (after 30 days off work, repayments would be paid until you returned to work) Redundancy cover If you work more than 16 hours per week, cover for redundancy (repayments covered up to 12 months); a back-to-work service would be available Hospital Cover If you have retired from work or are over 65 and under 70, cover for periods of hospitalisation (1/30th repayment cover for each day in hospital repayments covered up to 12 months) IAREP/SABE ROME 2008

  5. THEORIES 1 • Subjectively Expected Utility Theory (Savage 1954) • People will take the option with better subjectively expected utility. Predicts that preferences for payment protection insurance will be sensitive to changes in the cost of the insurance and the level of cover. IAREP/SABE ROME 2008

  6. THEORIES 2 • Bounded rationality (Simon 1957) • Simplified models of insured events. People have limited cognitive abilities to digest the complexities of different insurance policies and therefore use decision rules and heuristics. This predicts that people will not be sensitive to changes in level of insurance cover. IAREP/SABE ROME 2008

  7. THEORIES 3 • Huber’s Risk Defusing Operator Model (1997, 2007) • A risk defusing operator (RDO) is an additional action carried out by the decision maker (DM) and is expected to reduce risk. • Risk sufficient – search for RDO. • Successful search – accept RDO or not? • DM weighs up positive effect of RDO against cost. IAREP/SABE ROME 2008

  8. HUBER THEORIES 3B • Payment Protection insurance - a Precaution RDO -compensation for a possible problem with repayment take out insurance at the time of loan decision. • Huber’s theory predicts that cost of insurance and it’s cover will be evaluated – i.e. will PPI be a suitable RDO? • Huber’s theory therefore predicts that the cost and cover of insurance will be sensitive to variation. • PPI or another RDO? Other possible RDO – worst case plan (Using savings if in repayment difficulties) IAREP/SABE ROME 2008

  9. Aims of Research • To test Choices between Credit with PPI (different levels of cover and cost) or credit without PPI but with higher APR. • To investigate consumers’ evaluation of PPI levels of cover (premium or basic) • To investigate consumers’ ratings of usefulness of PPI cover and willingness of pay for PPI. IAREP/SABE ROME 2008

  10. HYPOTHESES • As cost of PPI increases, take up will decrease. • As cost of alternative credit option without PPI increases, take up of PPI will increase. • As level of cover is enhanced, the take up of insurance will increase. • Participants will be willing to pay more for premium than basic cover. • Perceived usefulness of components of PPI cover will predict choice for PPI and willingness to pay for it. IAREP/SABE ROME 2008

  11. METHOD • Postal questionnaire-based experiment. • 4 PPI loan decision scenarios presented for 36 months, • 2 for £7,500 and 2 for £15,000. • Loan choice of Bank A with PPI or Bank B no PPI. • Bank A with PPI offered 7.2% APR. Bank B, no PPI offered 2 loans at 8.3% APR and 2 loans at 12.9% APR • Randomised groups design, 2 x 2 • Level of PPI cover (Premium vs. Basic) • Cost of PPI (Expensive vs. Budget) • Correlation design with respect to variables for • Usefulness of aspects of cover, willingness to pay, demographics etc. • 2000 bank customers mailed, 11% response rate IAREP/SABE ROME 2008

  12. Example of PPI Decision Scenario • Imagine that you have decided to take out a bank loan for £7,500 to be repaid over 36 months. You have been given information from two banks, one of them included the above payment protection insurance (PPI) in their offer, the other does not please consider whether you prefer the terms offered by bank A or B. (£252.10) and (£9,075.60) = replacement budget priced PPI in 2 versions

  13. Example from PPI questionnaire Premium (2 groups) and Basic (2 groups) Cover Variations All participants had 1-4 elements of PPI. Two premium groups, also had 5 & 6 & no restriction on accident & sickness cover, and up to 12 months on hospital cover.

  14. RESULTS 1 Total percentages choosing PPI in each scenario across all versions. Pattern for 1 & 3 and for 2 and 4 very similar.

  15. Results 2: Percentage of participants in each version choosing PPI in scenario 1 & 2 IAREP/SABE ROME 2008

  16. Results 3 : Percentages choosing PPI over the alternative loan at APR 8.3%. Scenario 1 Not significant. 2 (6) = 2.75, p = .839

  17. Results 4: Percentages choosing PPI over the alternative loan at APR 12.9%. Scenario 2 PPI decision x PPI Cost 2 (4) = 0.74, p = .946 Main effect PPI Cost 2(1) = 29.9, p < .05

  18. Summary of Results from scenarios No significant effect of COVER or COST in scenarios 1 & 3 where alternative loan was 8.3% APR No significant effect of COVER variation in scenarios 2 and 4 where alternative loan was 12.9% APR Significant effect of PPI COST in scenarios 2 and 4 where alternative loan was 12.9% APR Significant effect of relative cost, i.e. cost of alternative without PPI IAREP/SABE ROME 2008

  19. PARTICIPANTS ASKED TO RATE ELEMENTS OF PPI COVER FOR USEFULNESS.Premium (2 groups) and Basic (2 groups) Cover Variations What is the MOST per month on top of the loan repayments you would be prepared to pay? £5.00  £10.00  £15.00  £20.00  £25.00  £30.00  £35.00  £40.00  £45.00  £50.00  £55.00  £60.00 

  20. Results 5: Ratings of usefulness of PPI components of cover IAREP/SABE ROME 2008

  21. Results 6: Ratings of usefulness of PPI components of cover All elements of PPI rated as useful by participants in all 4 groups. Accident and sickness cover No difference Premium (until return to work) vs. Basic (12 months max) Hospitalisation cover No difference Premium (12 months) vs. Basic (3 months)

  22. Results 7: Percentage of participants and the MOST they were willing to pay for Payment Protection Insurance (per month) 60% prepared to pay up to £10 per month (market rate at least £25).

  23. Results 8 - Willingness to Pay for PPI • Despite evaluations of usefulness most participants were not prepared to pay average market price (i.e. £5 per £1K) • Level of cover offered was not reflected in participants willingness to pay. Little difference between premium and basic groups, (basic cover groups prepared to pay slightly more). IAREP/SABE ROME 2008

  24. RESULTS 9. Predicting Choice for PPI • Hierarchical multiple regression analysis; factors predicting PPI choice • - not predicted by willingness to pay • - not predicted by demographic factors • - Sum of ratings of 4 usefulness factors – Critical illness, life, accident & sickness hospitalisation (provided in all versions) DID Predict PPI choice. Dependent variable: PPI decisions. Step 1 (Gender, age, income) % of variance only 2% Step 2 (PPI usefulness) % of variance 16% (R = .40, R2 = .16, R2 change = .14, p < .001) IAREP/SABE ROME 2008

  25. Conclusion & Discussion 1 – Sensitivity to Cost • Take up of PPI did decrease as predicted by SEU and Huber when the cost increased, but only when the alternative without PPI was expensive. • When the cost of an alternative credit option without PPI increased, the take up of PPI increased. This explains differences in take up between scenarios 1 & 3 where the cost of the alternative loan was relatively less than in scenarios 2 & 4 where the alternative was more expensive. IAREP/SABE ROME 2008

  26. Conclusion & Discussion 2 – Sensitivity to Cover • When premium insurance was offered, take up of PPI did not increase significantly, as predicted by SEU and Huber. • Participants were not willing to pay more for premium insurance than the basic policies. • Is PPI cover difficult to evaluate in isolation? • Bounded rationality theory assumes that people use simplifications of decision alternatives rather than look at detail. Does this explain lack of sensitivity to cover? Do people have time or inclination to read the small print to understand complexities of insurance policies? IAREP/SABE ROME 2008

  27. Thank you for your time. IAREP/SABE ROME 2008

  28. CREDIT CONSUMERS’ PAYMENT PROTECTION INSURANCE DECISIONS: THE EFFECT OF RELATIVE COST AND LEVEL OF COVER.REFERENCES and Useful papers • Huber, O. (1997). Beyond gambles and lotteries: naturalistic risky decisions. In R. Ranyard, W.R., Crozier and O. Svenson (eds.) Decision making: Cognitive models and explanations. London: Routledge. • Huber, U. (2007) . Behaviour in Risky Decisions: Focus on Risk Defusing. In:Abdellaoui, M; Luce, R.D.; Machina, M.J.; Munier, B. (eds).Uncertainty and Risk: Mental, Formal, Experimental Representations. (291-306). Berlin, New York: Springer. • Kunreuther, H. (1996). Mitigating disaster losses through insurance. Journal of Risk and Uncertainty 12, 171-187. • Loewenstein, G., Weber, E.U., Hsese, C. & Welch, N. (2001). Risk as feelings. Psychological Bulletin, 127, 267-286. • Office of Fair Trading. (2006b). Payment protection insurance. Report on the market study and proposed decision to make a market investigation reference. London: HMSO. • Plous, Scott. The Psychology of Judgment and Decision Making. 1996 McGraw-Hill, USA • Ranyard, R., Hinkley, L., Williamson, J., & McHugh, S.(2006). The role of mental accounting in consumer credit decision processes. Journal of Economic Psychology, 27, 571-588. • Ranyard, R., & McHugh, S.(2005). Consumer credit and payment protection insurance decisions. Unpublished report, University of Bolton. • Savage, L. J. (1954). Foundations of statistics. Oxford, England: Wiley. • Simon, H.A. (1957) Models of man: social and rational. New York: Wiley. • Simon, H.A. (1990). Invariants of human behavior. Annual Review of Psychology, 41, 1-19. • Szrek, Helena; Baron, Jonathan. The value of choice in insurance purchasing. Journal of Economic Psychology. Vol 28(5), Oct. 2007, pp. 529-544. • Tversky, A., & Kahneman, D. (1974). Judgment under uncertainty: Heuristics and biases. Science, 185(4157), 1124-1131. • Williamson, J., Ranyard, R. & Cuthbert, L. (2000a). Conversation-based process tracing methods for the study of naturalistic decisions: an evaluation study. British Journal of Psychology, 91, 203-221. Contact for further information. Contact details:- Rob Ranyard, Health & Social Studies, University of Bolton, Deane Road, Bolton, BL3 5AB., UK Sandie McHugh, Health & Social Studies, University of Bolton, Deane Road, Bolton, BL3 5AB, UK . sjm1pls@bolton.ac.uk. rr1@bolton.ac.uk

More Related