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Behavioral Finance Research in Action

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

I'm here at the Financial Behavior in Retirement Summit, and I'm joined today by Brian Gaffney. He is the CEO of Allianz Global [Investors Distributors].

Brian, thanks so much for being here today.

Brian Gaffney: My pleasure, Christine.

Benz: So, you and your firm, Brian, have recently done a lot of work on the area of behavioral finance, and I'm wondering if you can talk about some of the key takeaways from all that research?

Gaffney: Yes, the reason that we've done the study is, there are 79 million people heading for retirement, and many of them are very poorly prepared. The Department of Labor is concerned, Department of Treasury, so they issued a request for information. And our view is, if we put our asset management lens on, we could give some technical guidance, but we felt that it was better to understand that decision making is critical to the end results of being able to retire with dignity.

So, we engaged professor Shlomo Benartzi to engage 10 experts in the area of behavioral finance in our response to just understand particularly how people make decisions after they stop working and they're in retirement.

Benz: Right. So, one of the things that you brought out in your presentation was extreme loss aversion on the part of some retirees. So, they would rather risk nothing even if it means a minimal or zero gain. How does the financial services industry combat that tendency? How do you work against that and get retirees to take appropriate risks?

Gaffney: The common set of understandings up until the most recent study was that people are twice as averse to risk. So, you feel the pain of loss twice as much as you feel the gain of winning a $100. The importance of understanding as it relates to how we create solutions is that when you're asking people to make decisions about giving up control of their assets, giving up control for protection, people see that as loss.

And so the solutions need to be framed in a way that liquidity may be available rather than giving up complete control or encouraging a feeling that could very much feel like loss but you don't know the way you've constructed the products.

Benz: So, a related question Brian is, how you see the financial services landscape evolving so that insurance products increasingly intersect with traditional financial products like stocks and bonds?

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Gaffney: In many case, they do already today in the case of variable annuities, the underlying investments are typical asset management investments, but the proper solutions may entail a deeper combination between the two. For example, you've got totally different regulatory bodies on the asset management side than you do not the insurance side. Insurance is regulated by state government.

So, generating the expertise on both the asset management and the insurance features is a challenge for the industry, but the correct solutions will involve elements of insurance that may not even be engineered or manufactured today in conjunction with discussion with asset management firms with an understanding of how people behave and make decisions to craft and create and engineer better solutions that include both.

Benz: And it seems like one challenge right now is that a lot of advisors aren't conversant in both types of products.

Gaffney: Right.

So Brian, you also talked about what you perceive as some real successes, drawing from the world of behavioral finance and putting them in place in the financial services industry. Can you talk about some of those?

Gaffney: Some of the studies regarding things like inertia addressed the deferral rates. Deferral rates are remarkably low in the 401(k) world. The introduction of auto enrollment was a function of work done by behavioral scientists. And it showed that if you had to do something you were less likely to take the appropriate action. So, auto enrollment emerged and became part of the Pension Protection Act and that was delivered by behavioral finance.

A study of Save More for Tomorrow was an exercise to try to get people to make decisions about increasing or escalating their contributions down the road because if we ask them today, people can't find things in the future that are more important or interesting than what they're doing today. So, if you ask them today, will you defer in the future, they'll say, yes. But if we ask them today, will you increase your rate of deferral, they'll say, no. So, again behavioral finance has played a part actually in the accumulation of billions of dollars as a result of auto enrollment and auto escalation. And we think there is a lot more that can be done.

Benz: Well, Brian, great research. Thanks for sharing your insights, today. We appreciate it.

Gaffney: Thanks, for having me. I appreciate it.