1. BEHAVIORAL RESEARCH & PRODUCT DEVELOPMENT FOR FINANCIAL WELLNESS October 2011 JONATHAN ZINMAN Professor, Dartmouth College Academic Director, U.S. Household Finance Initiative, IPA

2. My Approach Today October2011 Financial Products Innovation Fund Outline problems and opportunities  Symptoms of financial illness  Causes (Behavioral Economics 101) Outline disciplined approach to address these problems using behaviorally-driven R&D Put forth ideas for product-focused R&D under USHFI Ford initiative. Key criteria:  Behaviorally-informed development on new products or features  Potential for scalability  For passing market or sustainability test

3. Financial Illness: Symptoms October 2011 Widespread low financial resiliency Little savings for many households High debt reliance: expensive High “money on the table”  Poor shopping, mediocre mgmt  Low financial sophistication Financial Products Innovation Fund

4. Financial Illness: Causes (Behavioral Economics 101a) October 2011 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 Financial Products Innovation Fund

5. Financial Illness: Causes (Behavioral Economics 101b) October 2011 Mistakes borne of misguided heuristics, other cognitive limitations  Information/choice overload  Anchoring  Low (financial) literacy, numeracy # 2 Financial Products Innovation Fund

6. Financial Illness: Causes (Behavioral Economics 101c) October 2011 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 Financial Products Innovation Fund

7. Financial Illness: Causes (Behavioral Economics 101d) October 2011 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 Financial Products Innovation Fund

8. “Win-win” Opportunity and Approach October2011 Use insights from behavioral social sciences to: Help financial service providers innovate and succeed  Whatever their bottom line(s) Help end-users make better decisions Financial Products Innovation Fund

9. 3-Pronged Approach to R&D October 2011 Behavioral Research on what makes consumers and markets tick  Lots of suggestive evidence from theory, lab, surveys (much of it competing)  Little actionable evidence from real-world settings of interest  Very logic of behavioral research suggests that setting can matter a lot: importance of “context”, “frames”, “cues”, etc. # 1 Financial Products Innovation Fund

10. 3-Pronged Approach to R&D October 2011 “D” based on “R” Work with financial service providers to apply behavioral research through innovations in:  Product development  Pricing  Marketing  Enrollment  Customer communication # 2 Financial Products Innovation Fund

11. 3-Pronged Approach to R&D October 2011 Testing keeps the “R” and “D” honest Work with financial service providers to evaluate innovations:  Develop success/failure metrics  Implement gold-standard methodologies that deliver sharp, actionable results E.g., Randomized-Control Trials (RCT) Adapted per operational realities, other constraints  Reveal mechanisms underlying success or failure A first-step is often an “alpha test”: if you build it, do people want it? Can you sustain it?  This is the focus of our Ford Initiative  Of course an RCT component will make a proposal more attractive Or a clear path to an RCT after alpha test concludes # 3 Financial Products Innovation Fund

12. Experimentation & the Learning Organization October 2011 A Virtuous Cycle: RDTest Financial Products Innovation Fund

13. The Skinny on Seven Product Ideas Pay Back Yourself – Convert loan payments to savings once loan paid off Borrow Less Tomorrow – Save More Tomorrow with bigger bang for buck Personal Loan Shopper – Search is where the money is Card Control Features – Making them work: specs, marketing, communication, pricing Affordable Small Dollar Loans – Innovations in distribution, intermediation, screening Frictionless Saving – Get people when they’re liquid: impulse/on-demand saving Private Banking for Main Street – Solutions for the entire household balance sheet October 2011 Financial Products Innovation Fund

14. Idea 1. Pay Back Yourself  Problem: hard to get started saving.  Solution: seamless conversion of loan payments to savings/investment once loan paid off  Small-dollar loans, auto loans, home equity,  Approach: harness habit formation, redirect implusivity  Key features: upfront commitment, back-end automation  Can reinforce this with messaging  “You’ve almost paid off your loan, get ready to pay yourself”  “… paid off your car/home, time to save for maintenance” October 2011 Financial Products Innovation Fund

15. Idea 2. Borrow Less Tomorrow Problem: yield-maximizing strategy for many households is to pay down high-interest debt Solution: target this “investment opportunity” with behavioral levers Marketing for attention and motivation: Help consumers identify whether they should borrow less Simple Decision Aid: Help making concrete plan to borrow less – Accelerate repayment – Limit borrowing going forward Commitment: Offer creative ways for clients to incentivize themselves o *Social commitment: peer supporters/referees o Financial commitment: performance bonds o Access commitment: “cut me off if I don’t…” Ongoing Messaging: Feedback/reminders for follow-thru and maintenance October 2011 Financial Products Innovation Fund

16. Idea 3. Personal Loan Shopper Problem: consumers pay too much for loans – mortgages (Hall&Woodward); cards (Stango&Zinman) – because they hate to shop, don’t know how, inattention, etc. Solution: shopping engine Consumers passively input information – Credit report access – Account access Engine outputs product recommendations – And/or general guidelines: “don’t pay more than this” – And/or fills out application forms? – And/or negotiates for the client? October 2011 Financial Products Innovation Fund

17. Idea 4. Card Control Problem: consumers lack (self-)control Solution: MasterCard inControl-type features. Allow holder can self-impose spending limits based on – Time (“no charging on Fridays”) – Amount (per-transaction, per time period) – Place: merchant, merchant category Challenge: value as consumer commitment contract? – Communicating value to consumer (framing issue) – Providing UI that helps consumer use wisely Don’t want people calling in to revoke/change limits – Pricing/monetizing E.g., teaser subscription pricing strategies October 2011 Financial Products Innovation Fund

18. Idea 5. Small Loans, Big Impacts Problem: small-dollar loans are expensive – Wrong term structure: way too short Potential solution 1: delayed disbursement as screening technique – “Pre-approval” with no disbursement for a week or so – Borrower willing to take this deal probably has their act together: lower risk Potential solution 2: deliver through workplace – Use data on job stability to lessen, price credit risk – Use HR to intermediate (info, education, messaging) for better outcomes Adapting lessons from retirement savings (401k) October 2011 Financial Products Innovation Fund

19. Idea 6. Frictionless Saving Easy to spend on impulse, but not to save When can you save on impulse? When liquid. When liquid? Tax time. – Auto transfers from refund to savings already making inroads. Other liquid time? Payday! So we’re looking for ways to clear path to saving at: – Check cashing window – Direct deposit (increase adoption of auto-transfer to savings) October 2011 Financial Products Innovation Fund

20. Idea 7. Private Banking for Main Street Idea: services at level of the household balance sheet One motivating trend: “forced ” or “collateralized” saving is popular feature of small-dollar lending worldwide: require savings deposit(s) along with loan repayment Problem: at market rates this is a money pump! Approach: redirect psychology of mental accounting and habit formation in more (cost)-effective directions Solutions: – Lend less, message to mental account for that, smooth transition to saving on back-end – Force saving, but pay loan rate on that saving. This makes business sense if habits can be formed with little saving – Offset account that allocates liquidity from liquid assets to loan repayment based on automated rules (a la Redfrog) October 2011 Financial Products Innovation Fund

21. Summing Up These ideas merely a sample of our favorites, we are open to others Ford initiative requires first two stages of R&D: product development and “alpha-testing” for feasibility and level of demand – Adding third stage, randomized-control testing to measure impacts cleanly, will strengthen proposal Product development work only part of our research portfolio: feel free to contact us with other ideas and areas of interest October 2011 Financial Products Innovation Fund

22. Content and Contacts More content at:  www.dartmouth.edu/~jzinmanwww.dartmouth.edu/~jzinman  www.poverty-action.org/ushouseholdfinancewww.poverty-action.org/ushouseholdfinance Questions, vetting ideas?  Rebecca Rouse: rrouse@poverty-action.orgrrouse@poverty-action.org October 2011 Financial Products Innovation Fund