Why Life Insurance Should Look More Like a 401(k)

You Don’t Need It Until You Need It

I am a genuine believer in the value of life insurance. It’s a product that, when priced fairly, is invaluable.

In the case of someone close to me whose mother passed away during his youth, this product was the only reason his family was able to keep their home, buy food, and make ends meet at a fundamental level.

Yet, why is this darn thing so hard to sell?

Death and Marshmallows

“Life insurance is sold, not bought,” or so goes the aphorism.

Essentially, life insurance, for the most part, is just plain difficult to sell for many agents. I chalk this up to two things, both of which are fundamentally rooted in the human psyche:

1. Death: Life insurance is a product that makes us think of death, which most of us make an overt effort to forget. Although on some level we don’t walk around denying that we’ll be buried in the earth in the not-too-distant future, most of us push the thought away, as it’s simply too unpleasant.
2. Marshmallows: It’s the classic Walter Mischel psychology experiment at Stanford that many of us have heard of a thousand times: one marshmallow in hand now is worth more than two in five minutes. Humans are wired to discount future value, and so we typically plan too little, too late, whether it involves life insurance or retirement savings.

Enter the Coronavirus

Coronavirus has made a significant impact on the first of these two challenges, by making death much more salient on a nearly ongoing basis for most of the last several months. In a place like New York City, for example, death rates in 2020 are 580% higher than normal.

This has been a boon for life insurance applications, with many in the industry reporting 35-50% increases in applications.

It has not, however, helped us overcome the “marshmallow challenge.” In fact, it has made it more difficult. Budgets are tighter, unemployment levels are at historical highs, and people are living much more in a “one-marshmallow world" than before.

The Missing Piece: Applying 401(k) Behavioral Finance Innovation

There’s a lot to be learned from the 401(k) industry, which faced similar behavioral hurdles and immense consumer inertia.

Shlomo Ben-Artzi and Richard Thaler saw these challenges as an opportunity for behavioral finance innovation.

They conducted academic research and ultimately developed a methodology called “Save More Tomorrow” for 401(k) plans.

Roughly summarized, the best practices that evolved from this work called for:

1. Opt-Out: Participants were automatically enrolled in a 401(k) plan by default. No forms or other actions were needed. Participants had to take steps to opt out, rather than sign up. This process counters our inertia.
2. Pre-Commitment Tied to Future Savings: Rather than asking participants to save more up front, plans prompted participants to commit to saving more after a future pay increase. This process counters our hyperbolic discounting.
3. Auto-Escalate: They made it easy for plans to have employees “auto escalate” by increasing savings rates over time, but further out in the future, typically after pay increases. This process counters loss aversion.

These innovations are not new; they were developed several decades ago, and are now well entrenched across the industry.

Behavioral Finance for Life Insurance Coverage

There has been an increasing number of behavioral finance innovations applied to existing life insurance policy holders, which have especially helped policy holders stay healthy and engaged.

However, there’s been a dearth of innovation in applying these principles to get people covered in the first place, and then seamlessly increase their coverage over time.

Imagine a world in which group life insurance providers start implementing similar innovations. Providing some basic form of group life coverage is pretty standard these days, but it doesn’t solve the problem fully, since:

1. This coverage is usually very limited in size.
2. It doesn’t track true coverage needs or adjust over time.
3. Changes are usually made during annual enrollment periods, and more coverage requires thought, more upfront costs, and deliberate changes.

Hence, this plan design goes against the grain of how we’re wired as human beings, and shares many of the same challenges faced by 401(k) plans before Save More Tomorrow was implemented.

What Might Life Insurance Behavioral Innovation Look Like?

Innovation in the space would include many of the components in the Save More Tomorrow approach, including:

1. Automatic Enrollment Based On Life Events: One could imagine a policy through which employers automatically provide life insurance coverage (or a higher amount of coverage) upon a life event like the birth of a first child, or an elderly dependent being added to one’s medical policies. By tying these to medical coverage changes, an employee receives coverage seamlessly, while reducing adverse selection for carriers.
2. Auto-escalate: Automatically increase coverage amounts based on income levels. This is a feature in some plans now, and broader adoption would be beneficial at a societal level.
3. Opt-Out, Enhanced by Portability: Employers would provide much higher levels of coverage, enabling one’s group life benefit to approximate coverage needed if one shopped for an independent policy. However, the challenge here is making it portable via a rollover equivalent - so one could take the group policy to another employer or convert to a standalone policy, without re-pricing it.

The above is all at the group level, but I could imagine innovative direct carriers and MGAs adopting similar innovations into their policies.

Of course, this is not a direct analogy to 401(k) coverage, and perhaps most importantly, the topic of seamless and cost-effective portability is critical - which might require legislation to create COBRA-like protection for these policies.

My Wish for Public Policy Santa Claus

Stepping back for one moment, what’s happening here is that the private sector will continue to sweat hard, working to find innovations to help people get coverage, overcome behavioral barriers, and build profitable businesses. This is really tough work, yet there is a better, unlikely, solution: good public policy.

If I had a wish here, for both the life insurance and retirement savings industries, it would be thoughtful public policy that mandates coverage and savings.

In this world, we’d all be required to save for retirement and have reasonable coverage for life insurance. Thoughtful regulators would establish policies to either provision this as a public good (e.g., public healthcare) or carefully craft a private sector marketplace for coverage. Some portion of tax revenues would be used to provide coverage for those who lack the ability to pay.

In the retirement world, the few countries that have mandated such policies have seen tremendous success.

Australia, for example, has a mandated retirement savings policy. As a result, it has the fourth highest pension market value in the world (131% of GDP), even though it’s the 55th most populous nation.

Again, I’m in public policy dreamland here, but I would hope for a world in which Democrats and Republicans unite, with Democrats citing the societal benefits of such savings with regard to improving quality of life for all, and Republicans lauding the growth of a larger retirement and insurance industry, and less pressure on social security.

The Landscape for Life Insurance Innovation Is Open

Today, the vast majority of startup innovation in life insurance is focused on customer acquisition, often by targeting specific niches. Although this is beneficial around the margins for improving coverage, this is often a long slog, difficult to scale, and doesn’t really solve the core behavioral problems facing the industry.

In the end, there’s a big opportunity for startups and large companies alike. The winners will build large businesses and benefit the lives of those they serve.