Improving arrears management - one behavioural insight at a time

Authored by Paul Adams and Patricia de Jonge (with Dutch version here )

The Authority for Financial Markets (AFM) recently published feedback on how firms interact with customers who are facing difficulty repaying their debts, also known as arrears management in English (or “achterstandbeheer” in Dutch) [1]. In its feedback, the AFM notes the need for insights from behavioural science to help improve things. We - both being behavioural scientists and former regulators - wholeheartedly agree with this approach. But what does it actually mean? In this article, we will try to demystify some of the core concepts and point to some ways firms can help their consumers.???

“The AFM wants providers to provide sustainable solutions… making use of insights from behavioural sciences” [1]

The focus on behavioural science is not new. The AFM’s first report on consumer behaviour was published in 2015 [2]. And earlier this year they provided renewed focus for all firms in the financial sector by publishing these principles [3] and this supporting research [4]. Specifically, the AFM sets out the following 3 principles for firms to follow:

1. Keep up to date with the most relevant consumer behavioural insights
2. Use these insights to promote sensible decisions among consumers
3. Measure the effect of using behavioural insights

But what does this all mean for credit providers? And how can firms start to apply behavioural science to their business, and to their arrears management specifically? We set out some ideas below, structured around the principles. If you’re keen to learn more, or have specific questions, do get in touch!?

Principle 1: Keep up to date with the most relevant consumer behavioural insights

“All providers can grow by continuously monitoring the new developments from the behavioural sciences and apply relevant new insights in their approach.” [1]

Behavioural science is a broad collection of disciplines focused on understanding human behaviour. It takes its inspiration (and methods) from psychology, behavioural economics, sociology, anthropology, marketing and other academic and applied disciplines. As such, it provides a broad lens through which to understand human behaviour in general and consumer’s financial decisions specifically.?

At its core, behavioural science teaches us that we are rarely completely rational when we decide. Instead, a lot of what we do is intuItive and automatic, influenced by our social environments, and by the way choice or information is presented to us. And usually that’s perfectly fine, and simply a very efficient way to get stuff done. But it can cause problems - for example when managing debt. We know, for example, that making well-considered, long-term focused financial decisions can be particularly hard for people [5] - and that poverty and stress make this even harder [6]. We also know that people sometimes suffer from information avoidance - which is exactly what it sounds like: the idea that we actively avoid information on topics that we’re worried about [7]. And that emphasizing that something is really important can, counterintuitively, lead to procrastination [8]

This is only just scratching the surface - there is a wealth of research on consumers’ financial decision making [9 and 10] and the specific ways that it can go wrong. And yes, we can help you fill the gaps in your knowledge. But the key takeaway here is actually fairly simple: you need to question your own ideas and assumptions about why your customers behave as they do. Imagine, for example, that you send out a reminder letter to customers who’ve missed a loan payment, but the response rate is disappointingly low. Given what we know about response rates, this shouldn’t be a huge stretch of your imagination! The common response to this would be to interpret this lack of response as a lack of motivation, or an unwillingness to pay. But with a behavioural lens, you might unearth all kinds of other explanations: maybe your letter was too threatening, which caused people to put their heads in the sand instead of respond. Maybe the information about how to pay was hidden somewhere in a byline, instead of prominently displayed. Or maybe the timing was off, and people received the letter just when their current account balance was at its lowest.

Principle 2: Use these insights to promote sensible decisions among consumers

“...one of the key lessons is to make it as simple as possible for people to make sensible financial decisions” [5]

Once you’ve understood why and how people make decisions, and where these might not be in their best interest, the AFM expects you to use these insights when designing your information provision and something called the choice environment. They also want you to use them when developing new products, but that is less relevant here. We’ll get back to the choice environment in a bit, but first let’s focus on designing information in such a way as to help guide sensible decisions.?

The AFM themselves identify a few things that providers can do to improve communication: keep the language in written and oral communication simple and jargon free, make the availability of repayment options salient and easy to access, and display empathy with the client’s situation.?

In addition, we think firms could look into various ways of communicating monetary amounts, and the effect this has on consumer behaviour. For example, in a famous study from the US, a different way of displaying fees and offering comparisons helped consumers make more sensible decisions [11]. For consumer credit providers, reframing the costs of not paying in real € amounts could help consumers to understand the true costs of their inaction.?

In a slightly different setting, researchers found that reframing savings choices into per-day amounts (e.g. “€1 a day”) rather than per-month amounts (“€30 a month”) quadruples the number of people saving, especially amongst low income consumers [12]. There could be good reasons to think that reframing repayment amounts into per-day amounts might help consumer credit customers understand the size of the commitment they need to make, relative to other daily expenses.?

More generally, making the most important information the most salient can have a positive effect on people’s ability to respond. Work by one of us shows that including the key messages in 3 short bullet points at the top of the letter more than doubled response rates, in this case, to a communication campaign offering compensation to customers [13].

These examples focus on how information can be presented in different ways to encourage responsible behaviour from consumers. The AFM also mentions the importance of looking at the choice architecture. This refers to the idea that the context in which people make decisions and the way in which choices are presented make a difference to the decisions people ultimately make.?

In this context, choice architecture could primarily be used to help encourage consumers to take action, either in the form of catching up with repayments or getting in touch with the company to ask for help. The AFM already mentions that letters to consumers could include QR codes that could link directly to payment journeys. Along similar lines, an email campaign from Capital One included direct links to set up new repayments on an existing credit card. By including these direct links, 12% more consumers increased their repayments [14].

Principle 3: Measure the effect of using these insights

“It is important to test – in advance – whether the intervention will achieve the intended result. In some cases, an intervention will achieve exactly the opposite of what was intended.” [4]

In this article we’ve raised a few ideas of what might affect consumer decision making when it comes to repaying missed bills, as well as a few examples of where information or choice architecture might help consumers act in their best interests. But these are taken from various different studies which reflect different countries, different decisions to be made and different decision making contexts. And your context, your customers and the situation they find themselves in will probably be different. And so the final principle is to make sure you test and measure the effects of any changes you implement so that you can be sure that your intervention is really working.?

The idea of testing interventions as rigorously as possible is one of the foundations of behavioural science. Ideally that should be through a “randomised controlled trial” or “field trial” with your customers making real decisions in their real lives. The idea is similar to the medical trials that we put COVID vaccines through recently - a representative? group from the population is selected and half are randomly allocated to receive a placebo, while the other half receive the?vaccine. If the samples are large enough, and we take care with how we separate the two groups of people, then by comparing the two groups then we can see the effect of the vaccine on infection rates. Importantly we can also observe the potential for side-effects - this is important in the context of arrears management too, as we don’t want our interventions to have any harmful unintended consequences for those who receive them. ?

Such field trials are increasingly common in public policy [15] and commercial settings [16], and indeed have been used by the AFM themselves [17]. We’ve led the design and delivery of many such trials. But even where these are not possible, there may be other ways in which you develop and test interventions and understand how your customers react to them. Prototyping, user design and qualitative research can help iron out the biggest blindspots in your communications and customer journeys. Online experiments can test understanding and intentions in hypothetical situations. And historical data analysis might be able to uncover the effects of past interventions on behaviours. There are caveats with all of these of course, but better to try and to understand the limitations, then to have to explain to the AFM why you didn’t try!

The AFM wants credit providers to use behavioural insights to improve arrears management. We’ve explained what that means in practice, using three principles: Research your customers' behaviour, and make sure you truly understand what is stopping them from acting in their own best interest - don’t trust your intuitions. Use existing research and your own to come up with solutions for the barriers and drivers of behaviour that you’ve uncovered. And last but not least, make sure you test and learn from the results.

References:

1. AFM (2021). https://www.afm.nl/nl-nl/consumenten/nieuws/2021/november/onderzoek-achterstandsbeheer-aanbieders-krediet
2. AFM (2015). Standardized products and consumer financial decision-making
3. AFM (2021). Principles for the use of consumer behavioural insights
4. AFM (2021). Consumer behaviour: Understanding, guiding and measuring
5. Laibson, D. (1997). Golden Eggs and Hyperbolic Discounting , The Quarterly Journal of Economics, Volume 112, Issue 2, May 1997, Pages 443–478.
6. Mani, A., Mullainathan, S., Shafir, E., and Zhao, J. (2013). Poverty impedes cognitive function . Science, 341, 976–980
7. Golman, R., Hagmann, D. and Loewenstein, G. (2017). Information Avoidance . Journal of Economic Literature, 55 (1): 96-135
8. O'Donoghue, T. and Rabin, M. (1999). Doing It Now or Later . American Economic Review, 89 (1): 103-124
9. Greenberg, A.E. and Hershfield, H.E. (2019). Financial decision making . Consumer Psychology Review. 2019; 2: 17– 29
10. Beshears, J., Choi, J., Laibson, D. and Madrian B.C. (2018). Behavioral Household Finance . In: Bernheim, D., Laibson, D. and DellaVigna S. Handbook of Behavioral Economics - Foundations and Applications 1. Elsevier; 2018
11. Bertrand, M. and Morse, A. (2011). Information Disclosure, Cognitive Biases, and Payday Borrowing . The Journal of Finance, 66: 1865-1893
12. Hershfield, H.E. Shu, S. and Benartzi, S. (2020). Temporal Reframing and Participation in a Savings Program: A Field Experiment . Marketing Science 2020 39:6, 1039-1051
13. Adams, P. and Hunt, S. (2013). Encouraging consumers to claim redress: Evidence from a field trial , Financial Conduct Authority Occasional Paper
14. FCA (2016). Credit Card Market Study, Annex 4: Behavioural Trials
15. OECD (2017). Behavioural Insights and Public Policy. Lessons from Around the World
16. Luca, M. and Bazerman, M. H. (2020). The Power of Experiments: Decision-Making in a Data-Driven World . Cambridge, MA: MIT Press, 2020
17. AFM (2019). Making it easier to borrow responsibly. The effect of online choice architecture on consumer borrowing behaviour