Behavioural finance in credit insurance
by Daina Muceniece, Trade Credit Underwriter, Sompo Canopius (‘Canopius’)
by Daina Muceniece, Trade Credit Underwriter, Sompo Canopius (‘Canopius’)
With trade credit market becoming more and more competitive, each broker and insurer is
trying to find a way to improve their offering and reduce their claims. And when we think of
increasing speed, efficiency and overall customer experience we immediately turn our focus
to technology. We rush to improve our customer portal, provide instant pricing and risk
decisions online, find clever ways to collect more and more data and so on. All of these are
fantastic developments in trade credit market and I am a big supporter of such technological
innovations. However in all the excitement over innovation we have put technology before
people. But focus on people and, more specifically, human behaviour can help us to make
the most effective business decisions and therefore reach our business targets.
I believe our focus has switched to technology because technology is a lot easier to
understand and comprehend than people. But we forget that our business theories and
models are built with a key assumption that our clients, brokers and insurers will make
rational decisions at all times and even when put under pressure. However, behavioural
finance has shown that we are very far from rational. Therefore no pricing model, loss
projection or probability of default will ever be 100% correct (or most of the time not even
50% correct), because human element always plays a role and because human decisions
are not always rational.
That is why it is possible for one client to have a major loss while the other has no claim at
all given identical industry, buyer portfolio and trade credit policy. Because we are not
always rational, my vet is able to sell ear drops with the same ingredients but different
packaging for both £7 and £15. Sometimes we just prefer to buy a more expensive item
making ourselves believe that it’s better quality (anchoring bias), or other times we keep
believing that our buyer will pay off the overdue despite a number of failed rescheduling
plans (optimism bias).
Behavioural finance or behavioural economics combines three fields of science –
neuroscience, psychology and economics/finance. It aims to understand how people make
decisions, what affects their decision making and how to adapt or modify behaviours to
achieve the most efficient results for ourselves and our clients. (Note that reference to client
can mean broker, insurer or insured depending on your standpoint.)
Whether you are an insurer, broker or insured behavioural finance can help you and your
clients to make more effective decisions. As a broker you can apply behavioural finance to
better understand your client and insurers. For example, if your client has illusion of control
bias then they are likely to underestimate their previous losses and more tempted to become
self-insured. In this instance, correct the bias by clearly outlining loss history and
recommending a clear log of decisions, overdues and losses for future records. This client
may have significant overdues on their balance sheet but be refusing to accept the loss
(sunk-cost fallacy).
As an insured, you can benefit by reviewing biases in your sales, collection and credit
management teams. Recognising, understanding and mitigating biases in your team will
lead to more effective, consistent long term performance.
Framing bias is very common and people often try to use it in their advantage. Framing bias
presents itself when we process information in different ways depending on how it is
presented and therefore make different business decisions. For example, are you more likely
to support a client that has 60% success rate or 40% loss rate? If you or your client shows
signs of framing bias, then try to remove facts from the context and view them in an
unbiased form.
As Excess of Loss (XoL) insurers, understanding our clients is a key part of what we do. We
provide s significant level of authority to our client to make their own decisions, thus putting
control in our client’s hands. XoL policies also provide non-cancellable limits, which means
that again credit management control is left to our client. The only way that we can
effectively manage such product is by trusting our client. And the only way to trust our client
is to understand their goals, their way of thinking, their business DNA. That means we need
to understand their biases, because they affect the way the sales person, the collection
agent, credit manager and CFO will interpret information, and therefore how they make
decisions. That is how we can continue to support a client in a declining industry despite
cover being reduced in the market, or the reason why we may offer a troubled buyer for one
insured and not the other, or why we may not increase a deductible after a bad underwriting
year. But in order to know your client it is not sufficient to read their credit management
procedures and bios on directors. Insurers and brokers have to spend more time with their
clients and prospective clients.
When we take the time to understand our own and the biases of others, the door to
enormous potential is open. It can lead us to more effective and successful business
decisions and long term trusting and supporting customer relationships.